Abe Forrester an three of his friends from college have interested a group of ve

Question

Abe Forrester an 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 accesories. 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 82,000 shares of common stock. Plan B would involve issueing $1.2 million dollars in long term bonds with an effective interest rate of 12.3% plus $1.1 million would be raised by selling 41,000 shares of common stock. The debt funds raised under Abe and his partners plan to use a 35% 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 part a. that shows the EPS will be the same regardless whether PLAN A B is chosen. Find the EBIT indifference level associated with the two financing plans. The EBIT indifference level associated with the twp financing plans is $

Explanation / Answer

EBIT indifference level associated with the two financing plans is $319,800. Stock Plan A EBIT $319,800 Less: Interest Expense 0 Earnings Before Taxes $319,000 Less: Taxes at 40% (127,920) Net Income $191,880 Number of Common Shares 84,000 EPS 2.28

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