(EBIT-EPS Analysis) Abe Forrester and three of his friends from college have int
ID: 2726047 • Letter: #
Question
(EBIT-EPS Analysis) 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. To finance the new venture two plans have been proposed. Plan A is an all common equity structure in which $2.1 million dollars would be raised by selling $84,000 shares of common stock Plan B would involve issuing $1.2 million in long term bonds with an effective interest rate of 12.2 percent plus another $0.9 million would be raised by selling 42,000 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 firms capital structure.
Abe and his partners plan to use a 38 percent tax rate in their analysis and theyu 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.) The EBIT indifference level associated with the two financing plans is $_______. (Round to the nearest dollar.)
B.) Complete the segment of the income statement for Plan A below: (Round income statement amounts to the nearest dollar except the EPS to the nearest cent.)
Stock Plan EBIT Less: Interest Expense Earnings Before Taxes Less: Taxes at 38% Net Income Number of Common Shares EPS Bond/Stock Plan EBIT Less: Interest Expense Earnings Before Taxes Less: Taxes at 38% Net Income Number of Common Shares EPSExplanation / Answer
Plan Plan A Plan B Shares of Equity 2100000 900000 Debt 1200000 Cost of debt 12.20% Interest Expense 146400 Tax Rate 38% 38% EBIT indifference point is the point where EPS is same under both the option EBIT*(1-.38)/(84000)…….eq 1 ((EBIT-146400)*(1-.38))/(42000)…….eq 2 Solving Above Equation We get EBIT =292800 Plan A Plan B EBIT 292800 292800 Less: Interest Expense 146400 Earnings Before Taxes 292800 146400 Less: Taxes at 38% 111264 55632 Net Income 181536 90768 Number Of Common Shares 84,000 42,000 EPS 2.16 2.16
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