Abe Forrester and three of his friends from college have interested a group of v

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 vaccum 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 which $2.3million dollar would be raised by selling 80,000 shares of common stock.

- Plan B would involve issuing $1.1 million dollars in long-term bonds with an effective interested rate of 11.6% plus $1.2 million would be raised by selling 40,000 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 40% 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 incmoe statement for the ebit level solved for in part a. that shows the eps will be the same regardless wheter plan A or B is chosen

ONly need these answered:

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

"The earnings before interest and taxes (EBIT) and earnings per share (EPS) are two important figures to understand when you are trying to raise money for a company. Three basic ways to raise money are: issuing preferred stock, issuing common stock and borrowing money. By graphing the earnings per share for various projected EBIT earnings, you can determine where the common stock EPS crosses over the other two lines. These are indifference points--the points where it doesn't matter which one you use, because the EPS will be the same either way."

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