Yongman Electronics has decided to invest $10,000,000 in a new headquarters and
ID: 2648431 • Letter: Y
Question
Yongman Electronics has decided to invest $10,000,000 in a new headquarters and needs to determine the best way to finance the construction. The firm currently has $50,000,000 of 10 percent bonds and 4,000,000 common shares outstanding. The firm can obtain the $10,000,000 of financing through a 10 percent bond issue or the sale of 1,000,000 shares of common stock. The firm has a 40 percent tax rate.
(a) What is the degree of financial leverage for each plan at $25,000,000 of EBIT?
(b) What is the financial breakeven point for each plan?
Explanation / Answer
Current capital employed structure
10% bonds $ 50,000,000
4,000,000 common shares $ 40,000,000
Tax Rate : 40%
Total new investment needed : $ 10,000,000
Alternative 1
10% bonds $ 10,000,000
Alternative 2
1,000,000 common shares $ 10,000,000
(a) What is the degree of financial leverage for each plan at $25,000,000 of EBIT?
Earnings before interest & taxes (EBIT)
Financial Leverage = ----------------------------------------------------
Earnings before tax
Earnings before interest & taxes (EBIT)
= ----------------------------------------------------
EBIT
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