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 $2.1 million dollars would be raised by selling 90,000 shares of common stock.
Plan B would involve issuing ?$1.4 million in? long-term bonds with an effective interest rate of 11.8 percent plus another$ 0.7million 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:
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.