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Answered: - Debt vs. Equity -- Financing Decision Problem The XYZ Airl


Debt vs. Equity --?Financing Decision Problem

The XYZ Airlines would like to expand operations. ?In order to do so, the company plans to purchase a new airliner for $27,000,000.

The following facts apply:

1) ?XYZ pays a 30% tax on corporate profits.

2) ?There are currently 120,000 shares of XYZ common stock outstanding.

3) ?Careful analysis by the XYZ CFO shows that the addition of the airliner to the XYZ fleet will likely increase net income (before interest and taxes) by $8,000,000/year.

4) ?XYZ can finance the purchase of the new airliner one of two ways --

A) ?By issuing new common stock at $30/share, or

B) ?By issuing $27,000,000 in corporate bonds paying 10% interest.

Required:

1) ?How much does XYZ's net income per year increase under plan A? ?Under plan B?

2) ?How much does XYZ's EPS increase per year under plan A? ?Under plan B?

3) ?Which plan is better? ?Why?

4) ?Explain how the concept of risk might relate to this problem.


a.

 

Tax rate

 

Outstanding shares

 

Cost of new airliner

 

EBIT

 

Issuance price of new shares

 


 

30%

 

120,000

 

$27,000,000

 

$8,000,000

 

$30

 

Plan A

 

EBIT

 

Less: taxes

 

Net income

 


 

Rate of ne

 

10%

 

Bond

 

$27,000,000...

 


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