(EBIT-EPS analysis) Abe Forrester and three of his friends from college have int
ID: 2745048 • 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. 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 $2.4 million dollars would be raised by selling 86,000 shares of common stock.
Plan B would involve issuing $1.1 million in long-term bonds with an effective interest rate of 12.4 percent plus another $ 1.3$ million would be raised by selling 43,000 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 35 percent 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.The EBIT indifference level associated with the two financing plans is
$nothing .
(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 35%
Net Income
$
Number of Common Shares
EPS
$
Complete the segment of the income statement for Plan B below:(Round income statement amounts to the nearest dollar except the EPS to the nearest cent.)
Bond/Stock Plan
EBIT
$
Less: Interest Expense
Earnings Before Taxes
$
Less: Taxes at 35%
Net Income
$
Number of Common Shares
EPS
$
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Less
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Sol a). The EBIT indifference level associated with the two financing plans
b) Preparation 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.
The income statement for Plan A:
The income statement for Plan B:
EBIT indifference level of the two financing plan = EBIT(1-tax rate)/No. of shares = (EBIT- intrest) (1-tax rate )/No. of share EBIT(1-0.35)/86,000sh = (EBIT- $136,400) (1-0.35 )/43,000sh EBIT= $272,800Related Questions
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