tment opportunities and little debt financing ined with healthy profits that pro

Question

tment opportunities and little debt financing ined with healthy profits that provide them with free cash flow, their man- ent team might squander the firm's earnings on questionable investments. -(who have established three successful businesses. The proposed plan t effort involves a series of international retail outlets to distribute and ties in Latin America such as Panama City, Bogotá, São Paulo, and Bue- com IT-EPS analysis) Bill and Kate Theil are not only husband and wife but en- LO for their lates rvice a or ther ll line of ingenious home garden tools. The stores would be located in ires The entrepreneurs have proposed two financing plans. Plan A is an all on equity structure. Five million dollars would be raised by selling 160,000 common of common stock. Plan B would involve the use of long-term debt financing. million dollars would be raised by marketing bonds with an effective interest e of 14 percent. Under Plan B, another $2 million would be raised by selling 64,000 hares of common stock. With both plans, $5 million is needed to launch the new im's operations. The debt funds raised under plan B are considered to have no fixed maturity date because this portion of financial leverage part of the company's capital structure. The two promising entrepreneurs have de- is thought to be a permanent cided to use a 35 percent marginal 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 proposals. b. Prepare income statements for the two plans that prove EPS will be the same regardless of the plan chosen at the EBIT level found in part (a) logo professors has decided to form

Explanation / Answer

(a) Indifference Level EBIT            100.00             100.00 Interest                     -                 14.00 EBT            100.00               86.00 Tax              35.00               30.10 Net Income              65.00               55.90 Shares        1,60,000             64,000 ROI 0.0406% 0.0873% Ratio 2.15 1 (b) EPS will be same EBIT            215.00             100.00 Interest                     -                 14.00 EBT            215.00               86.00 Tax              75.25               30.10 Net Income            139.75               55.90 Shares        1,60,000             64,000 ROI 0.0873% 0.0873% EPS       0.000873        0.000873

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