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Joyford Bat Company currently has $3millionin debt outstanding,bearing an interest rate of 12 percent.It wishes to financea $4 million expansion program and is
considering three alternatives:additional debt at 14 percent interest (option 1) ,preferred stock with a 12 percent dividend (option2), and the sale of common stock at $16 per share(option3). The company currently has 800,000 shares of common stock outstanding and is in a 40 percent tax bracket.
(a) If earnings before interest and taxes are currently $1.5million, what would be earnings per share for the three alternatives,assuming no immediate increase in operating profit?
(b) Determine the indifference point between the debt plan and the common stock plan and interpret the results.
(c) Compute the degree of financial leverage (DFL) for each alternative at the expected EBIT level of $1.5million.
(d) Which alternative do you prefer? How much would EBIT need to increase before the next alternative would be ‘better’ in terms of EPS?
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