Abe Forrester and three of his friends from college have interested a group fo v
ID: 2650883 • Letter: A
Question
Abe Forrester and three of his friends from college have interested a group fo 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 Antonia. 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 88,000 shares of common stock.
Plan B would involve issuing $1.3 million dollars in long term bonds with an effective interest rate of 11.7% plus $0.9 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 firms capital structure.
Abe and his partners plan to use a 34% tax rate in their analysis, and they have hired you on a consulting basis to do the following:A.
1. 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)
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.
ebit
Less: int expense
Earnings before Taxes
tax @ 40%
net income
no of common shares
Plan A Plan Bebit
Less: int expense
Earnings before Taxes
tax @ 40%
net income
no of common shares
epsExplanation / Answer
Answer:1 Calculation of the EBIT indifference level:
Plan A: EBIT/88000
Plan B: (EBIT - 152100)(1-0.34)/44000
Plan A=Plan B
EBIT*44000=(EBIT-152100)(0.66)*88000
44000 EBIT=58080 EBIT-8833968000
-14080 EBIT= -8833968000
EBIT=627412.5
Answer:B
Particulars Plan A Plan B EBIT 627412.5 627412.5 Less: int expense 0 152100 EBT 627412.5 475312.5 Less: tax expense 250965 190125 EAT 376447.5 285187.5 No of share 88000 44000 EPS 4.2778 6.48153