Gear Co has computed its indifference level of EBIT to be $50,000 between an equity financing option and a debt financing option. Interest expense under the debt option is $25,000 and $10,000 under the equity option. The EBIT for the firm is approximately normally distributed with an expected value of $62,000 and a standard deviation of $19,000. What is the probability that the equity financing option will be preferred

26.43%

Explanation:

The Z-score is needed to find the probability of having EBIT lower than $50,000.

Z-score = The Indifference point - The Expected EBIT / Standard Deviation

Z-score = $50,000 - $62,000 / $19,000

Z-score = -$12,000 / $19,000

Z-score = -0.63

From the standard normal distribution table, the probability that z-score will be less than -0.63 is 0.2643. So therefore, the probability of the equity financing will be preferred is 0.2643.

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