Question: (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 88,000 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 44,000 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 40 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.)
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Stock Plan
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EBIT
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$
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Less: Interest Expense
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Earnings Before Taxes
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$
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Less: Taxes at 40%
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Net Income
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$
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Number of Common Shares
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EPS
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$
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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.)
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Bond/Stock Plan
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EBIT
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$
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Less: Interest Expense
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Earnings Before Taxes
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$
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Less: Taxes at 40%
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Net Income
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$
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Number of Common Shares
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EPS
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$
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