Cybernauts, Ltd., is a new firm that wishes to determine an appropriate capital structure. It can issue 16 percent debt or 15 percent preferred stock. The total capitalization of the company will be $5 million, and common stock can be sold at $20 per share. The company is expected to have a 50 percent tax rate (federal plus state). Four possible capital structures being considered are as follows: PLAN DEBT PREFERRED EQUITY 1 0% 100% 2 30 7 3 50 50 4 50 30 a, Construct an EBIT-EPS chart for the four plans. (EBIT is expected to be $1 million.) Be sure to identify the relevant indifference points and determine the horizontal-axis, intercepts. b. Using Eg, (16.12), verify the indifference point on your graph between plans | and 3 and between plans 3 and 4 «. Compute the degree of financial leverage (DEL) for each alternative at an expected EBIT level of $1 million. . Which plan is best? Why? Plan 1 3 4 EBIT (in thousands) $1,000 $1,000 $1,000 $1,000 Interest o 240 400 400 EBT $1,000 $760 $ 600 S$ 600 ‘Taxes 500 380 300 300 EAT s 500 $ 380 $ 300 $ 300 Preferred dividends o ° ° 150 EACS $ 500 $ 380 $ 300 $ 150 ‘Number of shares 250 175 125 5 EPS $ 2.00 $217 $ 240 $2.00The intercepts on the horizontal axis for the four plans are $0, $240,000, $400,000, and $700,000 respectively. With this information, the EBIT-EPS indifference chart is: ° 2 PS (n dolars) ° os fl 15 EDIT (n milion of dears)Hi-Grade Regulator Company currently has 100,000 shares of common stock outstanding with a market price of $60 per share. It also has $2 million in 6 percent bonds. The com- pany is considering a $3 million expansion program that it can finance with all common, stock at $60 a share (option 1), straight bonds at 8 percent interest (option 2), preferred stock at 7 percent (option 3), and half common stock at $60 per share and half 8 percent bonds (option 4). a. For an expected EBIT level of $1 million after the expansion program, calculate the ‘earnings per share for each of the alternative methods of financing. Assume a tax rate of 50 percent. b. Construct an EBIT-EPS chart. Calculate the indifference points between alternatives. ‘What is your interpretation of them? Additional-finaneing Plans 1 2) 3 a Present Half Capital All all All Common and stricture. _Common 8% Bonds__Preferred_ Half Bonds EBIT $1,000 $1,000 $1,000 $1,000 $1,000 Interest 120 120 360 120 240 EBT $880 S 880 $ 640 S880 $ 760 Taxes 440 440 320 440 380 EAT $440 S 440 $ 320 S$ 440 $ 380 Pref, Stk, Dividend 210 FACS $s 440 s 440 $ 230 $ 380 Shares outstanding 100 150 100 100 12s EPS $ 440 $2.93 S 3.20 $ 230 $3.04