Fazio Pump Corporation currently has 1.1 million shares of common stock outstanding and $8 million in debt bearing an interest rate of 10 percent on average. It is considering a $5 million expansion program financed with common stock at $20 per share being realized (option 1), or debt at an interest rate of 11 percent (option 2), or preferred stock with a 10 percent dividend rate (option 3). Earnings before interest and taxes (EBIT) after the new
funds are raised are expected to be $6 million, and the company’s tax rate is 35 percent.
a. Determine likely earnings per share after financing for each of the three alternatives.
b. What would happen if EBIT were $3 million? $4 million?$8 million?
c. What would happen under the original conditions if the tax rate were 46 percent? If the interest rate on new debt were 8 percent and the preferred stock dividend rate were 7 percent? If the common could be sold for $40 per share?