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Old Wednesday, April 16, 2014
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Quote:
Originally Posted by ayesha78 View Post
DP Company -----
(ii) Develop a break-even, or indifference chart for these alternatives. What are the
approximate indifference points? To check one of these points, what is the
indifference point mathematically between debt and common?
(iii) Which alternative do you prefer? How much would EBIT need to increase before the next alternative would be best?
[IMG][/IMG]

Mathematically, the indifference pt b/w Debt and common stock is,
EBIT * -920,000/800,000 = EBIT *-360,000/1,050,000

EBIT*250,000 = Rs. 966,000,000-288,000,000

EBIT= Rs. 2712

Note that for the debt alternative, the total before tax interest is rs. 920,000 (360,000+560,000), and this is the intercept on the horizontal axis. for pref. alternative , divide 480,000 by (1-.40) to get 800,000. when this is dded to 360,000 interest on existing debt , the intercept becomes 1,160,000.

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iii)
For the current EBIT level, com. stock is clearly preferable. EBIT would need to increse by Rs. 2712,000-1500,000 = 1212,000 before an indiffernce pt whr debt is reached. stronger case, no doubt, can be made for the debt as EBIT will not probably fall below the indif. pt. All the other things remain same.

--------------
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  #12  
Old Friday, August 01, 2014
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that's great to mention here
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