Acct 352 Question #1) BJ Farm Equipment Company (BJ) has 5 million common shares outstanding and $200 million of 8% coupon bonds

Acct 352 Question #1) BJ Farm Equipment Company (BJ) has 5 million common shares outstanding and $200 million of 8% coupon bonds.  BJ’s tax rate is 40%.  The company is planning a capital expansion, which will cost $150 million.  Expected earnings before interest and taxes, after the expansion, is $60 million per year.  The company regularly pays quarterly dividends of $1.25 per share to its common shareholders, and will continue to do so, regardless of how the expansion is financed.

The firm can raise funds for expansion through one of three alternatives:

Debt Issue                                          Preferred Share Issue                                    Common Share Issue

10% coupon rate                                 5 million shares                                                3 million shares

                                                                   $30 per share                                     $50 per share

                                                                   12% yield

Required:

1. Conduct an EBIT indifference analysis (Breakeven EBIT) for the financing alternatives Preferred Shares vs Common Equity and explain the significance of your findings.