incremental EBIT

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dinesh.sundrani

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The Orchid Growing Company (OGC) must increase the size of its facilities. The $50,000,000 expansion can be raised in two ways:
1. Issuing 25,000,000 common shares at $2.00 per share.
2. Issuing 10,000,000 common shares at $2.00 per share, and issuing a $30,000,000, 10-year note at 8%.
Based only on the information above and assuming a 40% tax rate, which level of incremental EBIT (operating income), $2, $4, $6, or $8 million, provides the same EPS from either financing choice?
a. $2,000,000
b. $4,000,000
c. $6,000,000
d. $8,000,000
What does Stalla want from this question??
- Dinesh S
 
Let X be the EBIT
X * .6 / 25 = EPS for case 1
Choice 2:
(X - 2.4) *.6 / 10 = EPS for Case 2
Both must be equal.
so
.6X / 25 = (.6X - 1.44)/10
or
6x = 15X - 36
X = 4 Million
 
cpk123 Wrote:
——————————————————-
> Let X be the EBIT
>
> X * .6 / 25 = EPS for case 1
>
> Choice 2:
> (X - 2.4) *.6 / 10 = EPS for Case 2
>
> Both must be equal.
>
> so
> .6X / 25 = (.6X - 1.44)/10
> or
> 6x = 15X - 36
>
> X = 4 Million
wooooooooo cpk, u simply rock!!
- Dinesh S
 
Hey guys,
A shortcut I remember reading…something along the lines of: You are indifferent to which financing choice you use (implying EPS is the same) when the EBIT/Cost = cost to finance. So since cost of financing is 8% you can just go through dividing the different EBIT’s by the Cost: 4,000,000/50,000,000 = 8%.
My wording probably sucks on my explanation, but I remember reading something about it…somewhere…gluck!
 
that’s a good point, Amtrack. you are right about that. we can just compare yields.
 
Amtrak Wrote:
——————————————————-
> Hey guys,
>
> A shortcut I remember reading…something along
> the lines of: You are indifferent to which
> financing choice you use (implying EPS is the
> same) when the EBIT/Cost = cost to finance. So
> since cost of financing is 8% you can just go
> through dividing the different EBIT’s by the Cost:
> 4,000,000/50,000,000 = 8%.
>
> My wording probably sucks on my explanation, but I
> remember reading something about
> it…somewhere…gluck!
Wow Amtrak, that’s a nice shortcut. Thanks!!
- Dinesh S
 
yes, we can compare the yield. And that formula only holds when the share price under the two methods are the same. If not, u have make adjustment. In this case, u can just use 8% * 50million=4 mil.
 
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