Calculate the indifference level of earnings

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Roberts Inc. is trying to decide how best to finance a start-up company investment: Two plans were suggested by the finance committee:

Plan I: An all equity capital structure. The project will be financed entirely by $2 million which would be raised by issuing common stock at $20 per common stock share.

Plan II: Introduced capital gearing. Bonds $1 million with an effective rate of 11% will be issued. The balance of $1 million will be raised by issuing common stock at $20 per common share. The corporate tax rate for Roberts Inc is 30%.

Problem i) Calculate the indifference level of earnings before interest and tax (EBIT) associated with the two financing plans.

Problem ii) If EBIT is expected to be $300,000 annually, which plan will result in a higher EPS? Give a detailed analysis of the firm's prospects.

Reference no: EM132620937

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