A group of graduate students has decided to form a small Internet Service Compan

Question

A group of graduate students has decided to form a small Internet Service Company in Brevard County. The company will service Brevard County home users and need $300 million to start the company. Two financing plans have been proposed by the investment banking firms. Plan A is an all common- equity alternative. Under this agreement, 3million common shares will be sold to net the firm $100 per share. Plan B involves the use of financial leverage (debt and equity). A debt issue with a 20-year maturity period will

be privately placed. The debt issue will carry an interest rate of 10 percent, and the principal borrowed will amount to $120 million. The corporate tax rate is 35 percent. If the detailed financial analysis projects that there is a 30% chance that EBIT will be $14.0 million, 40% chance that it will be $16.0 million, and 30% chance that it will be $18 million annually, which plan will maximize the wealth of the stockholders? (note: the problem is based on the understanding of financial statement and financial leverage)please show work

Explanation / Answer

Plan A All Equity Case

EPS = (EBIt-interest)*(1-tax)/shares

Expected EBIT = 30% *$14.0 + 40%*$16.0+30%*18 =$16 million

EPS = (16-0)*(1-35%)/3 =3.47

Plan B

Number of shares = (300-120)/100 =1.8 million

Interest = 120*10% = 12 million

EPS = (EBIt-interest)*(1-tax)/shares

EPS = (16-12)*(1-35%)/1.8 =1.44

Plan A maximize the wealth of the stockholders with higher EPS

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.