Question: (EBIT-EPS analysis) A group of retired college professors has decided to form a small manufacturing corporation. The company will produce a full line of traditional office furniture. The investors have proposed two financing plans. Plan A is an all-common-equity alternative. Under this agreement, 1 million common shares will be sold to net the firm $20 per share. Plan B involves the use of financial leverage. A debt issue with a 20-year maturity period will be privately placed. The debt issue will carry an interest rate of 10 percent, and the principal borrowed will amount to $6 million. The marginal corporate tax rate is 50 percent.
a. Find the EBIT indifference level associated with the two financing proposals.
b. Prepare a proforma income statement that proves EPS will be the same regardless of the plan chosen at the EBIT level found in part (a).
c. Prepare an EBIT-EPS analysis chart for this situation.
d. If a detailed financial analysis projects that long-term EBIT will always be close to $2.4 million annually, which plan will provide for the higher EPS?