Abe Forrester and three Of his friends from college have interested a group of venture capitalists in backing their. 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 88,000 shares of common stock.?Plan B would involve issuing $1.3 million dollars in long-term bonds with an effective?Interest rate of 12.1% plus another $1.0 million would be raised by selling 44,000 shares?Of common stock. The debt funds raise funder Plan B have no fixed maturity date, in?That this amount of financial leverage is considered a permanent part of the firmâ?Capital structure. Abe and his partners plan to use a 34% 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 Plan B is chosen
a. Find the EBIT indifference level associated with the two financing plans.
6.Three recent graduates of the computer science program at the University of Tennessee are forming a company that will write and distribute new application software for the iPhone. Initially, the corporation will operate in the southern region of Tennessee, Georgia, North Carolina and South Carolina. A small group of private investors in the Atlanta, Georgia are interested in financing the startup company and two financing plans have been put forth into consideration.The first plan(A) is an all common equity capital structure $2.4 million dollars would be raised by selling common stock at $20 per common share.
Plan B would involve the use of financial leverage. $1.3 million would be raised by selling bonds with an effective interest rate of 11.3% (per annum), and the remaining 1.1 mill would be raised by selling common stock at the $20 price per share. The use of financial leverage is considered to be a permanent part of the firms capitalization, so no fixed date is needed for the analysis. A 34% tax rate is deemed appropriate for the analysis.
A. Find the EBIT indifference rate associated with the two financing problems
B.A detailed financial analysis of the firms prospects suggests that the long term EBIT will be above $325,000 annually. Taking this into consideration, which plan will generate the higher EPS?
a. Find the EBIT indifference level associated with the two financing plans.