Introduction to Finance

b. 
Draw an EBIT/eps graph showing the various levels of eps and 
EBIT including the expected EBIT. What should A1 do in this 
case?
21. 
Challenge Problem
Big 10 + 1 Corp. intends to raise $5 million 
by one of two fi nancing plans:
Plan A: Sell 1,250,000 shares at $4 per share net to the fi rm
Plan B: Issue $5 million in ten-year debentures with a 9 percent 
coupon rate
The fi rm expects an EBIT level of $800,000. Currently Big 10 + 1 
has 100,000 shares outstanding and $2 million of debt with a 5 percent 
coupon in its capital structure. The tax rate is 34 percent.
a. 
Draw an EBIT/eps graph showing the various levels of eps and 
EBIT.
b. 
What is the EBIT indiff erence point?
c. 
When will eps be zero under either alternative?
d. 
What type of fi nancing should the fi rm choose?
e. 
Suppose under the equity fi nancing option at an EBIT level of 
$800,000, the fi rm’s price-earnings (P/E) ratio is 10; for the debt 
fi nancing option, the P/E ratio is 7. What should the fi rm do?
22. 
Challenge Problem
Champion Telecommunications is restruc-
turing. Currently Champion has no debt outstanding. After it restruc-
tures, debt will be $5 million. The rate off ered to bondholders is 
10 percent. Champion currently has 700,000 shares outstanding at 
a market price of $40/share. Earnings per share are expected to rise.
a. 
What minimum level of EBIT is Champion expecting? Ignore 
the consequences of taxes.
b. 
Calculate the minimum level of EBIT that Champion’s managers 
are expecting if the interest rate on debt is 5 percent.
c. 
Assume that Champion had EBIT of $2 million; was the leverage 
benefi cial in (a) or in (b)?

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