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(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 proposed:
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 11.6 percent plus another $ 1. 1 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 38 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 $___. (Round to the nearest dollar.) b. 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.) Stock Plan Earnings Before Taxes Less: Taxes at 38% Net Income Number of Common Shares EPS $ Complete the segment of the income statement for Plan B below: (Round income statement amounts to the nearest dollar except the EPS to the nearest cent.) Bond/Stock Plan EBIT $ [ -=_i, Less: Interest Expense I Earnings Before Taxes $ 1 Less: Taxes at 38% I Net Income $ 1 Number of Common Shares I EPS $ 1
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