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 common stock 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:
PLAN
1
2
3
4
DEBT
0%
30
50
50
PREFERRED
0%
0
0
20
EQUITY
100%
70
50
30
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 $1 million.
d. Which plan is best? Why?