# Fin – ebit indifference calculation problems

1. The target capital structure for QM Industries is 42% common stock, 13% preferred stock and 45% debt. If the cost of common equity for the firm is 17.2%, the cost of preferred stock is 10.3%, the before tax cost of debt is 7.4%, and the firm’s tax rate is 35%, what is QM’s weighted average cost of capital?

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1. Crypton Electronics has a capital structure consisting of 43% common stock and 57% debt. A debt issue of 1,000 par value, 6.1% bonds that mature in 15 years and pay annual interest will sell for \$979. Common stock of the firm is currently selling for \$30.26 per share and the firm expects to pay a \$2.17 dividend next year. Dividends have grown at the rate of 5.3% per year and are expected to continue to do so for the foreseeable future. What is Crypton’s cost of capital where the firm’s tax rate is 30%?

1. The target capital structure for Jowers Manufacturing is 49% common stock, 12% preferred stock, and 39% debt. If the cost of common equity for the firm is 20.4%, the cost of preferred stock is 12.9 %, and the before tax cost of debt is 9.8%, what is Jowers cost of capital? The firm’s tax rate is 34%.

1. As a member of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of a new packaging equipment for the plant. Under the assumption that the firm’s present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm’s capital as follows:

Bonds: \$4,400,000, Preferred stock: \$2,300,000, Common stock: \$6,300,000

To finance the purchase, Ranch will sell 10-year bonds paying 6.5% per year at the market price of \$1,067. Preferred stock paying \$2.07 dividend can be sold for \$24.03. Common stock for Ranch is currently selling for \$55.85 per share and the firm paid a #3.08 dividend last year. Dividends are expected to continue growing at a rate of 5.4% per year into the indefinite future. If the firm’s tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?

1. Abe Forrester and 3 of his friends from college have interested a group of venture capitalists in backing their business idea. The proposed operation would consist of a series of retail outlets to distribute and service a full line of vacuum cleaners and accessories. These stores would be located in Dallas, Houston, and San Antonio. To finance the new venture two plans have been proposed:
1. Plan A is an all-common-equity structure in which 2.5 million would be raised by selling 90,000 shares of common stock.

1. Plan B would involve issuing 1.3 million dollars in long term bonds with an effective interest rate of 12.1% plus 1.2 million would be raised by selling 45,000 shares of common stock. The debt funds raised under Plan B have no fixed maturity date, in that this amount of financial leverage is considered a permanent part of the firms capital structure. Abe and his partners plan to use a 40% tax rate in their analysis, and they have hired you on a consulting basis to do the following:

i. Find the EBIT indifference level associated with the two financing plans.

ii. Prepare a pro forma income statement for the EBIT level solved for in part i. that shows that EPS will be the same regardless whether Plan A or B is chosen.

1. Three recent graduates of the computer science program at the University of Tennessee are forming a company that will write and distribute new application software for the iPhone. Initially, the corporation will operate in the southern region of Tennessee, Georgia, North Carolina, and South Carolina. A small group of private investors in the Atlanta, Georgia area is interested in financing the startup company and tow financing plans have been put forth for consideration:
1. The firs plan is an all-common-equity structure. 2.4 million dollars would be raised by selling common stock at \$10 per common share.

1. Plan B would involve the use of financial leverage. 1.4 million dollars would be raised by selling bonds with an effective interest rate of 11.4% (per annum), and the remaining 1.0 million would be raised by selling common stock at the \$10 price per share. The use of financial leverage is considered to be a permanent part of the firm’s capitalization, so no fixed maturity date is needed for the analysis. A 35% tax rate is deemed appropriate for the analysis.

i. Find the EBIT indifference level associated with the two financing plans

ii. A detailed financial analysis of the firm’s prospects suggests that the long-term EBIT will be above 336,000 annually. Taking this into consideration, which plan will generate the higher EPS?

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