Please explain how to calculate the EBIT in the following problem: (EBIT-EPS ana
ID: 2702936 • Letter: P
Question
Please explain how to calculate the EBIT in the following problem:
(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 proprosed:
Plan A is all common-equity- structure in which 2.3 million dollars would be raised by selling 84,000 shares of common stock.
Plan B would involve issuing $1.1 million dollars in long term bonds with an effective interest rate of 11.6% plus $1.2 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’s capital structure.
Abe and his partners plan to use 34% 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 financial plans is $__?
(Round to the nearest dollar)
Explanation / Answer
EPS is same ;
EPS = (EBIT - Interest - Taxes)/shares
Taxes = 0.34*EBT = 0.34*(EBIT - Interest) ;
So
EPS = 0.66*(EBIT - Interest)/shares ;
Interest in Plan B = 1.1 million *11.6/100 = $ 0.1276 million = $127600
EPS(A) = EPS(B)
0.66* (EBIT)/84000 = 0.66*(EBIT - 127600)/42000
EBIT = 2*EBIT - 255200
EBIT = $ 255200 = $0.2552 million