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You have been asked to determine the EPS indifference EBIT* level for your firm using the following information. Under the high-leverage alternative (a D/E ratio of 1.50), the firm would have 50,000 common shares outstanding, its pre-tax cost of debt would be 8%, and the face value of its outstanding debt would be $750,000. Under the low-leverage alternative (a D/E ratio of 0.80), the firm would have 75,000 common shares outstanding, its after-tax cost of debt would be 4% and the face value of its outstanding debt would be $250,000. The firm's tax rate is 30%.
Required
a. Determine the firm's EPS indifference EBIT* given this information.
b. Explain what the EPS indifference EBIT* is and how it can be used to assist the firm make its capital structure choice.
c. If the firm's expected EBIT is $75,000, which capital structure alternative would you recommend?
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