 # incremental EBIT

The Orchid Growing Company (OGC) must increase the size of its facilities. The \$50,000,000 expansion can be raised in two ways: 1. Issuing 25,000,000 common shares at \$2.00 per share. 2. Issuing 10,000,000 common shares at \$2.00 per share, and issuing a \$30,000,000, 10-year note at 8%. Based only on the information above and assuming a 40% tax rate, which level of incremental EBIT (operating income), \$2, \$4, \$6, or \$8 million, provides the same EPS from either financing choice? a. \$2,000,000 b. \$4,000,000 c. \$6,000,000 d. \$8,000,000 What does Stalla want from this question?? - Dinesh S

Let X be the EBIT X * .6 / 25 = EPS for case 1 Choice 2: (X - 2.4) *.6 / 10 = EPS for Case 2 Both must be equal. so .6X / 25 = (.6X - 1.44)/10 or 6x = 15X - 36 X = 4 Million

good job cpk i got the same number

cpk123 Wrote: ------------------------------------------------------- > Let X be the EBIT > > X * .6 / 25 = EPS for case 1 > > Choice 2: > (X - 2.4) *.6 / 10 = EPS for Case 2 > > Both must be equal. > > so > .6X / 25 = (.6X - 1.44)/10 > or > 6x = 15X - 36 > > X = 4 Million wooooooooo cpk, u simply rock!! - Dinesh S

Choice 2: (X - 2.4) *.6 / 10 = EPS for Case 2 where dou get the 2.4???

Oh nm, thats the interest expense on the note haha

choice B for me as well.

good problem. i also got B.

Hey guys, A shortcut I remember reading…something along the lines of: You are indifferent to which financing choice you use (implying EPS is the same) when the EBIT/Cost = cost to finance. So since cost of financing is 8% you can just go through dividing the different EBIT’s by the Cost: 4,000,000/50,000,000 = 8%. My wording probably sucks on my explanation, but I remember reading something about it…somewhere…gluck!

that’s a good point, Amtrack. you are right about that. we can just compare yields.

Amtrak Wrote: ------------------------------------------------------- > Hey guys, > > A shortcut I remember reading…something along > the lines of: You are indifferent to which > financing choice you use (implying EPS is the > same) when the EBIT/Cost = cost to finance. So > since cost of financing is 8% you can just go > through dividing the different EBIT’s by the Cost: > 4,000,000/50,000,000 = 8%. > > My wording probably sucks on my explanation, but I > remember reading something about > it…somewhere…gluck! Wow Amtrak, that’s a nice shortcut. Thanks!! - Dinesh S

yes, we can compare the yield. And that formula only holds when the share price under the two methods are the same. If not, u have make adjustment. In this case, u can just use 8% * 50million=4 mil.

awesome - thanks amtrak