# FIN – EBIT indifference Calculation Problems

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?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 Cryptonâs cost of capital where the firmâs tax rate is 30%?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 firmâs tax rate is 34%.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 firmâs present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firmâs capital as follows:Bonds: \$4,400,000, Preferred stock: \$2,300,000, Common stock: \$6,300,000To 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 firmâs tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?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:Plan A is an all-common-equity structure in which 2.5 million would be raised by selling 90,000 shares of common stock.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.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: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.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 firmâ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 plansii. A detailed financial analysis of the firmâ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?