im still confused on this. Abe Forrester and three of his friends from college h
ID: 2745453 • Letter: I
Question
im still confused on this.
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 11.6 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 40 percent tax rate in their analysis, and they have hired you on a consulting basis to do the following: Find the EBIT indifference level associated with the two financing plans. 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 The EBII indifference level associated with the two financing plans is $ (Round to the nearest dollar.) 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) 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.)Explanation / Answer
Requirement a:
At EBIT indifference level, EPS will be same for the both plans.
Let EBIT indifference level be x
Then
(x(1-0.4))/86000 = ((x-(1.1m*11.6%))(1-0.4))/43000
0.6x/86000 = [(x-127600)0.6] / 43000
0.3x = 0.6x – 76560
X = $255200
EBIT indifference level = $255200
Requirement b:
Income Statement:
Particulars
Plan A
Plan B
EBIT
255200
255200
Less: Interest
0
-127600
EBT
255200
127600
Less: Taxes (40%)
-102080
-51040
Net Income (EAT)
153120
76560
Number of Common Shares
86000
43000
EPS
1.78
1.78
Particulars
Plan A
Plan B
EBIT
255200
255200
Less: Interest
0
-127600
EBT
255200
127600
Less: Taxes (40%)
-102080
-51040
Net Income (EAT)
153120
76560
Number of Common Shares
86000
43000
EPS
1.78
1.78
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