If you compare the yield of a municipal bond with that of a negotiable certificate of deposit, what is
the equivalent before-tax yield of the certificate of deposit if the municipal bond has a yield of 8
per year and the investor has a marginal
tax rate of 28?
A) 10.24 B) 11.11 C) 8.28 D) 9.30
Question 2
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.
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