(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 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 i n which $2.2 million dollars would be raised by
selling 82,000 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. 1 million would be raised by selling 41,000 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.
a. The EBIT indifference level associated with the two financing plans is $___. (Round to the nearest dollar.)
b. 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.)
Stock Plan
Earnings Before Taxes Less: Taxes at 38% Net Income
Number of Common Shares EPS
$
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.)
Bond/Stock Plan
EBIT $ [
-=_i,
Less: Interest Expense I
Earnings Before Taxes $ 1
Less: Taxes at 38% I
Net Income $ 1
Number of Common Shares I
EPS $ 1