The GCI Corporation is planning a $4,000,000 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 percent coupon rate. The firm's existing shares of preferred stock pay dividends of $2.00 per share. The company's corporate income tax rate is 46 percent. The company's balance sheet prior to expansion is as follows:
GCI 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)
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$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?