Question

This information will be used for two questions! 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 O $6,725,000 $5,150,000 $5,675,000 O $6,200,000 $4,625,000

Answer 1

1.
(x-20*10%-15*5%)*10^6/(500000)=(x-20*10%)*10^6/(500000+15*10^6/75)
(x-20*10%-15*5%)=(500000)/(500000+15*10^6/75)*(x-20*10%)
=>x=4.625000 million
=4625000

2.
Debt EPS=(3.25-20*10%-15*5%)*10^6/(500000)=1.00000

Equity EPS=(3.25-20*10%)*10^6/(500000+15*10^6/75)=1.78571

Choose the equity financing option