Sand Key Development Company has a capital structure consisting of $20 million of 10% debt and $30 million of common equity. The firm has 500,000 shares of common stock outstanding. Sand Key is planning a major expansion and will need to raise $15 million. The firm must decide whether to finance the expansion with debt or equity. If equity financing is selected, common stock will be sold at $75 per share. If debt financing is chosen, 5% coupon bonds will be sold. The firm's marginal tax rate is 34%. Determine the level of operating income at which Sand Key would be indifferent between debt financing and equity financing.

Sand Key Development Company has a capital structure consisting of $20 million of 10% debt and $30 million of common equity. The firm has 500,000 shares of common stock outstanding. Sand Key is planning a major expansion and will need to raise $15 million. The firm must decide whether to finance the expansion with debt or equity. If equity financing is selected, common stock will be sold at $75 per share. If debt financing is chosen, 5% coupon bonds will be sold. The firm's marginal tax rate is 34%. Determine the level of operating income at which Sand Key would be indifferent between debt financing and equity financing.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter12: The Cost Of Capital

Section: Chapter Questions

Problem 17P

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Brooks Corporation is financed with $32 million of 9% debt and $68 million of common equity. The firm has 1 million shares of common stock outstanding. Brooks needs to raise $25 million and is undecided between two possible plans for raising this capital:Plan A: Equity financing. Under this plan, common stock will be sold at $62.50 per share.Plan B: Debt financing. Under this plan, 11% coupon bonds will be sold.At what level of operating income (EBIT) will the firm be indifferent between the two plans? Assume a 34% marginal tax rate.
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