Balon Plastics, Inc is financed entirely with 3 million shares of common stock selling for $20 a share. Capital of

$4 million is needed for this year's capital budget.

Additional funds can be raised with new stock (ignore
dilution) or with 13 percent 10-year bonds. The firm's tax rate is 40 percent.
a. Calculate the financing plan's EBIT indifference point.
b. The expected level of EBIT is $10,320,000 with a standard deviation of $2,000,000. What is the probability
that EBIT will be above the indifference point?
c. Does the "indifference point" calculated in question (a) above truly represent a point where stockholders are
indifferent between stock and debt financing? Explain your answer.

a. (EBIT - 0)(1 - 0.4)/3,200,000 = (EBIT - 520,000)(1 - 0.4)/3,000,000
EBIT = $8,320,000
b. Z = (8.32 - 10.32)/2 = 1.00 to the left of the mean
P(EBIT L $8.32 million) = 1 - 0.16 = 0.84
c. No. Financial risk is ignored.