Question 1 DMC currently has 100,000 shares of common stock outstanding with a market price of $50 per share. It also has $2 million in 7% bonds currently selling at par. The company is considering a...

Question 1

DMC currently has 100,000 shares of common stock outstanding with a market price of $50 per share. It also has $2 million in 7% bonds currently selling at par. The company is considering a $4 million expansion program that it can finance either (I) all common stock at $50 per share, or (II) all bonds at 9%.

The company estimates that if the expansion is undertaken, it can attain, in the near future, $1 million EBIT.

1. The company’s tax rate is 40%. Calculate EPS for each plan.


2. Draw the EBIT-EPS graph.


3. What is the break-even or indifference point between the two alternatives?


4. Due to expansionary credit conditions / monetary policy, you expect that sales and EBIT next year would be greater than the break-even calculated in © above, what form of financing would you recommend?


5. Which plan is riskier, I or II? Why?