The House of Cars Inc. is considering a new investment that will cost $5,000,000 and is expected to increase the company's annual operating earnings (EBIT) by $1,000,000 per year from the current level of $1,750,000 to $2,750,000.The company can raise the $5,000,000 by (1) selling 50,000 shares of common stock at $100 each or, (2) selling bonds with a coupon rate of 8.5% that will net the company $5,000,000.The tax rate is 40%.Below is information on the company's existing capital structure: 

Existing Capital Structure

Book Value

Debt - Bonds 8% coupon

$6,000,000

Common Stock

11,250,000

Total Liabilities & Owners Equity

$17,250,000

Total common shares outstanding

150,000

a.If EBIT is only $2,000,000, which plan will result in the highest EPS?Show your work. 

b.If EBIT is $2,750,000, Which plan will result in the highest EPS?Show your work. 

c.Calculate the breakeven EBIT for each plan.  

d.At what level of EBIT will the company be indifferent between the 2 plans?  

e.Calculate EPS for each plan at this level of EBIT  

f.Which plan will have the higher DFL (Degree of Financial Leverage)? No calculation required  

g.Instead of Plan #1 (issuing 50,000 common shares), if the company decided they should issue only 25,000 common shares at $100 each and finance the remainder of the project with 4% preferred shares, what would the indifference point be? 

Answer rating: 100% (QA)

Solution To answer these questions we need to calculate the EPS Earnings Per Share for each plan under different scenarios and compare them Lets go step by step a If EBIT is 2000000 we need to calcula... View the full answer