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 consists 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 2.5 million would be raised by selling 86,000shares of common stock.
PLAN B WOULD INVOLVE issuing 1.1 million in long term bonds with an effective interest rate of 12.3 percent plus another 1.4 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 firms capital structure.
Abe and his partners plan to use 38 percent tax rate in their analysis and they hired a consulting basis to do the followinf
a. Find the EBIT INDIFERENCE 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.