Reference no: EM13840128
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 $2.5 million dollars would be raised by selling 82,000 shares of common stock.
• Plan B would involve issuing $1.1 million in long-term bonds with an effective interest rate of 11.8 percent plus another $1.4 million would be raised by selling 41,000 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 34 percent 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. The EBIT indifference level associated with the two financing plans is $
b. Complete the segment of the income statement for Plan A below
Stock Plan
EDIT
Less: Interest Expense
Earnings Before Taxes
Less: Taxes at 34%
Net Income
Number of Common Shares
EPS
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Complete the segment of the income statement for Plan B below
Bond/Stock Plan
EDIT
Less: Interest Expense
Earnings Before Taxes
Less: Taxes at 34%
Net Income
Number of Common Shares
EPS
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