Question

​(Related to Checkpoint​ 15.2)  ​(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 ​$2.2 million dollars would be raised by selling 82,000shares of common stock.

-Plan B would involve issuing $1.5million in​ long-term bonds with an effective interest rate of 12.4 percent plus another $0.7 million would be raised by selling 41,000 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 34 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.

Please solve both parts A and B

Answer 1