Cybernauts, Ltd., is a new firm that wishes to determine an appropriate capital structure. It can issue

Question:

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 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:

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 Eq. (16.12), verify the indifference point on your graph between plans 1 and 3 and between plans 3 and 4.
c. Compute the degree of financial leverage (DFL) for each alternative at an expected EBIT level of $l million.

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...