Sand Key Development Company has a capital structure consisting of $20 million o

Question

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, 6% 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.

Explanation / Answer

Answer: $5150,000

Equity Financing=Debt financing

[(EBIT-interest)*(1-tax)]/No of shares outstanding=[(EBIT-interest)*(1-tax)]/No of shares outstanding

[(EBIT-2,000,000)*(1-0.34)]/700000=[(EBIT-2,900,000)*(1-0.34)]/500000

500000[0.66EBIT-1320000]=700000[0.66EBIT--1914000]

330000-660,0000,00,000=462000EBIT-13398,000,00,000

-132000EBIT=-6798,000,00,000

EBIT=5150,000

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