Abe Forrester and three of his friends from college have interested a group of v
ID: 2626387 • Letter: A
Question
Abe Forrester and three of his friends from college have interested a group of venture capitalists in backing their business idea. The proposed operation would consist of a series of retail outlets to distribute and service a full line of vacuum cleaners and accessories. These stores would be located in Dallas, Houston, and San Antonio. To finance the new venture two plans have been proposed: Plan A is an all common equity structure in $2.2 million dollars would be raised by selling 88,000 shares of common stock. Plan B would involve issuing $1.4 million dollars in long-term bonds with an effective interest rate of 12.3% plus $0.8 million would be raised by selling 44,000 shares of common stock. The debt funds raised under Plan B have no fixed maturity date, in that this amount of financial leverage is considered a permanent part of the firm's capital structure. Abe and his partners plan to use a 38% tax rate in their analysis, and they have hired you on a consulting basis to do the following; A. Find the EBIT indifference level associated with the two financing plans. B. Prepare a pro forma income statement for the EBIT level solved for in Part a. that shows that EPS will be the same regardless whether Plan A or B is chosen. a. find the EBIT indifference level associated with the two financing plans. The EBIT indifference level associated with the two financing plans is $? Round to the nearest dollar.
Explanation / Answer
EPS from both the Plan A and Plan B should be same
(EBIT-Tax(Plan A))/88000 = (EBIT- Interest-Tax(Plan B))/44000
Interest from Plan B = 1400000*0.123=172,200
Tax(Plan A) =0.38 EBIT
Tax (Plan B)= 0.38EBIT-0.38(172,200) = 0.38EBIT -65,436
Using the above EPS equation
(EBIT-0.38EBIT)/88000 = (EBIT-0.38EBIT-172,200+65436)/44000
0.62EBIT= (88000/44000)*(0.62EBIT-106764)
0.62 EBIT = 1.24 EBIT - 213528
EBIT = 213528/0.62 =344,400
EPS from both the Plan A and Plan B should be same
(EBIT-Tax(Plan A))/88000 = (EBIT- Interest-Tax(Plan B))/44000
Interest from Plan B = 1400000*0.123=172,200
Tax(Plan A) =0.38 EBIT
Tax (Plan B)= 0.38EBIT-0.38(172,200) = 0.38EBIT -65,436
Using the above EPS equation
(EBIT-0.38EBIT)/88000 = (EBIT-0.38EBIT-172,200+65436)/44000
0.62EBIT= (88000/44000)*(0.62EBIT-106764)
0.62 EBIT = 1.24 EBIT - 213528
EBIT = 213528/0.62 =344,400
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.