Abe Forrester Abe Forrester and three of his friends from college have intereste

Question

Abe Forrester

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 $2.3 million dollars would be raised by selling 90.000 shares of common stock Plan B would involve issuing $1.3 million in long-term bonds with an effective interest rate of 118 percent plus another $1.0 million would be raised by selling 45.000 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 38 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 EBIT 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.)

Explanation / Answer

Indifference level:

Stock issued under plan 1 = 2300000 / 90000 =

X*(1-.38)/90000 = (X-1300000*.118)*(1-.38)/45000

.62X/90000*45000 = .62X - 95108

.31X = .62X - 95108

X = 306800

b) Income statement:

EBIT = 306800

Interest = 0

EBT = 306800

Tax = 116584

EAT = 190216

No of shares = 90000

EPS = 2.11

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