I\'m not really understanding EBIT at all, this is due by tonight, I am 8 months

Question

I'm not really understanding EBIT at all, this is due by tonight, I am 8 months pregnant and very tired. Please help!

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:
%u2022 Plan A is an all-common-equity structure in which $2.1 million dollars would be raised by selling 84,000 shares of common stock.
%u2022 Plan B would involve issuing $1.2 million dollars in long-term bonds with an effective interest rate of 11.8% plus $0.9 million would be raised by selling 42,000 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%u2019s capital structure.
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 in Part a. that shows that EPS will be the same regardless whether Plan A or B is chosen.

a. Find the EBIT indifference level associated with the two financing plans.
The EBIT indifference level associated with the two financing plans is $____. (Round to the nearest dollar.)

Explanation / Answer

EPS is same ;

EPS = (EBIT - Interest - Taxes)/shares

Taxes = 0.35*EBT = 0.35*(EBIT - Interest) ;

So

EPS = 0.65*(EBIT - Interest)/shares ;

Interest in Plan B = 1.2 million *11.8/100 = $ 0.1416 million = $141600

EPS(A) = EPS(B)

0.65* (EBIT)/84000 = 0.65*(EBIT - 141600)/42000

EBIT = 2*EBIT - 283200

EBIT = $ 283200 = $0.2832 million

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.