FQ Services is analyzing two financial plan for their newly form subsidiary. The

Question

FQ Services is analyzing two financial plan for their newly form subsidiary. The plans are described as follows:

Plan A Plan B
Bonds at 10%: RM50,000 Preferred stock: RM30,000
Common stock: RM100,000 Common stock: RM120,000

The common stock will be sold at RM10.00 per share and preferred stock will be sold at RM50.00 per share. Dividend for preferred stock would be RM2.00 per share. The corporate tax rate is 26 percent.

i) Find the EBIT-EPS indifferent point with the two plans.
ii) If the long-term EBIT will be above RM25,000 annually, which plan will generate a higher EPS? Show your calculation.
iii) Draw your EBIT-EPS analysis chart to show your answer in (i) and(ii).

Explanation / Answer

i) EPS=((EBIT - I) (1 - t) - Pref. Div))/# of Common Share PLAN A No of common stocks =RM100,000/10=10,000 EPS=((EBIT -10%*50,000 )*(1-26%)-0)/10,000 Plab B No of preferred stocks=RM30,000/50=600 EPS =(EBIT*(1-26%)-600*2)/12,000 ((EBIT -10%*50,000 )*(1-26%)-0)/10,000 =(EBIT*(1-26%)-600*2)/12,000 EBIT =RM21,900 EBIT-EPS indifferent point =RM21,900 ii)PLAN A EPS =((25,000 -10%*50,000 )*(1-26%)-0)/10,000 =RM1.48000 PLAN B =(25,000 *(1-26%)-600*2)/12,000 =RM1.4417 PLAN A will generate higher EPS

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