Plan 1 Plan 2 Interest Expense $25,000 $50,000 Preferred Dividend $3,000 $1,500
ID: 2646116 • Letter: P
Question
Plan 1 Plan 2
Interest Expense $25,000 $50,000
Preferred Dividend $3,000 $1,500
Common Shares Outstanding 200,000 100,000
A) Assuming a 40% percent tax rate,what is the financial breakeven point for each plan?
B)What is the degree of finanical leverage at a base level EBIT of $120,000 for both finaning plans? the firm has a 40% tax rate
C) what is the EPS under financing 1 ,if the firm projects EBIT of $200,000 and has a tax rate of 40%?
D) at about what level should the financial manager be indifferent to either plan?
E)Which plan is a higher degree of financial leverage and financial risk
Explanation / Answer
Answer A:
Financial Break Even Point =
Interest on Debt +
Preference Dividend
1- Tax Rate
Plan 1
Financial Break Even Point =
$25,000 +
$3000
1- 0.40
Financial Break Even Point = $ 25,000 + $5,000
Financial Break Even Point = $ 30,000
Plan 2
Financial Break Even Point =
$50,000 +
$1,500
1- 0.40
Financial Break Even Point = $50,000 + $2,500
Financial Break Even Point = $ 52,500
Answer B:
Particular
Plan 1
Plan 2
EBIT
$120,000
$120,000
Less: Interest
$25,000
$50,000
EBT
$95,000
$70,000
Degree of Financial Leverage
EBIT
EBIT
EBT -
Prefrence Dividend
EBT -
Prefrence Dividend
(1-Tax rate)
(1-Tax rate)
Degree of Financial Leverage
$120,000
$120,000
$95,000 -
$3,000
$70,000 -
$1,500
(1-0.40)
(1-0.40)
Degree of Financial Leverage
$120,000
$120,000
$95,000-$5,000
$70,000-$2,500
Degree of Financial Leverage
$120,000
$120,000
$90,000
$67,500
Degree of Financial Leverage
1.33 times
1.77 times
Answer C:
Table Showing Calculation of EPS for Option 1
Particular
Amount
EBIT
$2,00,000
Less: Interest
($25,000)
EBT
$175,000
Less: Tax @40%
$70,000
PAT
$105,000
Less: Preferred Dividend
$3,000
EAE
$102,000
EPS
EAE
Common Share Outstanding
EPS
$102,000
$200,000
EPS
$0.51 / Share
Answer D:
Calculation of Indifference Point:
(EBIT
Financial Break Even Point =
Interest on Debt +
Preference Dividend
1- Tax Rate