Jenkins Products has a current capital structure that consists of $50 million in long-term debt at an interest rate of 10 percent and $40 million in common equity (10 million shares). The firm is considering an expansion program that will cost $10 million.
This program can be financed with additional long-term debt at a 13 percent rate of interest, preferred stock at a cost of 14 percent, or the sale of new common stock at $10 per share. The firm’s marginal tax rate is 40 percent.
a. Compute the indifference point level of EBIT between the debt financing option and the common stock option.
b. Compute the indifference point level of EBIT between the common stock option and the preferred stock option.
c. Is there an indifference point between the debt and preferred stock options? Why or why not?