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 in which $2.3 million dollars would be raised by selling 90.000 shares of common stock.
• Plan B would involve issuing $1.3 million in long-term bonds with an effective interest rate of 11.8 percent plus another $1.0 million 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.
C. The EBIT indifference level associated with the two financing plans is $]. (Round to the nearest dollar)
D. 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
EBIT-
Less: Interest Expense-
Earnings Before Taxes-
Less: Taxes at 38%-
Net Income-
Number of Common Shares-
EPS-