Beijing Bearings Is Considering Purchasing a Small Firm in the Same

Essay

Beijing Bearings is considering purchasing a small firm in the same line of business.The purchase would be financed by the sale of common stock or a bond issue.The financial manager needs to evaluate how the two alternative financing plans will affect the earnings potential of the firm.Total financing required is $4.5 million.The firm currently has $20,000,000 of 12 percent bonds and 600,000 common shares outstanding.The firm can arrange financing of the $4.5 million through a 14 percent bond issue or the sale of 100,000 shares of common stock.The firm has a 40 percent tax rate.
(a)What is the degree of financial leverage for each plan at $7,000,000 of EBIT?
(b)What is the financial breakeven point for each plan?