Question

Mr. Brew Cafeteria has computed the indifference point between debt and common equity financing options to be $4 millions of EBIT. EBIT is approximately normally distributed with an expected value of $4.5 million and a standard deviation of $600,000. What is the probability that the equity financing option will be superior to the debt option

Answer 1

Answer: 20.33%

Step-by-step explanation:

The probability of having the equity financing option having higher figures than debt is the probability of having EBIT lower than the indifference point of $4million. We would use the z-score to find the probability of having a lower EBIT.

z-score = indifference point - expected EBIT/ standard deviation

Which would be; 4000000-4500000/600000= -0.83.

From our table, -0.83 is 20.33%.