Can someone break this down into steps? Abe Forrester and three of his friends f
ID: 2745311 • Letter: C
Question
Can someone break this down into steps?
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: Plan A is an all-common-equity structure in which $ 2.4 million dollars would be raised by selling 80,000 shares of common stock. Plan B would involve issuing $ 1.2 million in long-term bonds with an effective interest rate of 11.8 percent plus another $ 1.2 million would be raised by selling 40,000 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 a 40 percent tax rate in their analysis, and they have hired you on a consulting basis to do the following: Find the EBIT indifference level associated with the two financing plans. 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. The EBIT indifference level associated with the two financing plans is $. (Round to the nearest dollar.) Complete the segment of the income statement for Plan A below: (Round income statement amounts to the nearest dollar except the EPS to the nearest cent.)Explanation / Answer
a. The EBIT indifference level associated with two financing plans: $283,200.
Calculation:
Indifference level is the point of EBIT where EPS is same under two financing alternatives.
Formula to calculate indifference level,
EPS under alternate under second alternate
=> EBIT (1-tax rate) / Number of shares outstanding = (EBIT - Interest) (1-tax rate) / Number of shares outstanding
EBIT (1-40%) / 80,000 = {EBIT - (1.2million * 11.8%)} (1-40%) / 40,000
EBIT (0.6) / 80,000 = {EBIT - 141,600} (0.6) / 40,000
EBIT (0.6) = (0.6 EBIT - 84,960) * 80,000 / 40,000
EBIT (0.6) = (0.6 EBIT - 84,960) * 2
EBIT (0.6) =1.2 EBIT - 169,920
EBIT = 169,920 / 0.6 = $283,200
b. Computation of income statement for A and B below:
Plan A Plan B EBIT 283,200 283,200 Less: Interest - 141,600 Earnings Before Taxes 283,200 141,600 Less: Tax @40% 113,280 56,640 Net income 169,920 84,960 Number Of Common Shares 80,000 40,000 EPS 2.214 2.214