Abe Forrester and three of his friends from college have interested a group fo 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 Antonia. To finance the new venture two plans have been proposed: Plan A is an all common equity structure in which $2.4 million dollars would be raised by selling 86,000 shares of common stock. Plan B would involve issuing $1.3 million dollars in long term bonds with an effective interest rate of 12.4% plus $1.1 million would be raised by selling 43,000 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 firms capital structure. Abe and his partners plan to use a 38% 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.
Stock Plan
EBIT
Less: Interest Expense
Earnings Before Taxes
Less: Taxes at 38%
Net Income
Number of Common Shares
EPS