Problem:

High Sky, Inc., a hot-air balloon manufacturing firm, currently has the following simplified balance sheet: Assets Liabilities and Capital Total Assets $ 1,100,000 Bonds (10% interest) $ 600,000 Common Stock at par ($3), 100,000 shares outstanding $ 300,000 Contributed capital in excess of par $ 100,000 Retained earnings $ 100,000 Total liabilities and capital $ 1,100,000 The company is planning an expansion that is expected to cost $600,000. The expansion can be financed with new equity (sold to net the company $4 per share) or with the sale of new bonds at an interest rate of 11 percent. (The firm's marginal tax rate is 40 percent.) Compute the indifference point between the two financing alternatives. If the expected level of EBIT for the firm is $240,000 with a standard deviation of $50,000, what is the probability that the debt financing alternatives will produce higher earnings than the equity alternative? (EBIT is normally distributed.) If the debt alternative is chosen, what is the probability that the company will have negative earnings per share in any period? Explain in detail.