The MAX Corporation Is Planning a $4 Million Expansion This

Essay

The MAX Corporation is planning a $4 million expansion this year. The expansion can be financed by issuing either common stock or bonds. The new common stock can be sold for $60 per share. The bonds can be issued with a 12% coupon rate. The firm's existing shares of preferred stock pay dividends of $2.00 per share. The company's combined state and federal corporate income tax rate is 46%. The company's balance sheet prior to expansion is as follows:
MAX Corporation
Current assets $ 2,000,000
Fixed assets 8,000,000
Total assets $10,000,000
Current liabilities $ 1,500,000
Bonds:
(8%, $1,000 par value) 1,000,000
(10%, $1,000 par value) 4,000,000
Preferred stock:
($100 par value) 500,000
Common stock:
($2 par value) 700,000
Retained earnings 2,300,000
Total liabilities and equity $10,000,000
a. Calculate the indifference level of EBIT between the two plans.
b. If EBIT is expected to be $3 million, which plan will result in higher EPS?