. Three recent graduates of the computer science program at the Univ of Tennesse
ID: 2698512 • Letter: #
Question
. Three recent graduates of the computer science program at the Univ 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 area is interested in financing the group company and two financing plans have been put forth for consideration:
The first (Plan A) is an all common equity structure. $2.2 million dollars would be raised by selling common stock at $20 per common share.
Plan B would involve the use of financial leverage. $1.4 million dollars would be raised by selling bonds with effective interest rate of 10.7% (per annum), and the remaining $0.8 million 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 firm's capitalization, so no fixed maturity date is needed for the analysis. A 35% tax rate is deemed appropriate for the analysis.
a. Find the EBIT indifference level associated with the two financing plans.
The EBIT indifference level associated with the 2 financing plans is $ (round to nearest dollar)
b. A detailed financial analysis of the firm’s prospects suggests that the long-term EBIT will be above $306,000 annually. Taking this into consideration, which plan will generate the higher EPS?
Explanation / Answer
a)
.65x/110000=(x-149800).65/40000
solving x we get
x=235400
b)EBIT >235400 then plan using debt
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