Reference no: EM13517848

6. (EBIT-EPS analysis) Three recent graduates of the computer science program at the University of Tennessee are forming a company that will write and distribute new application software for the iPhone.. Initially, the corporation will operate in the southern region of Tennessee, Georgia, North
Carolina and South Carolina. A small group of private Investigators in Atlanta, Georgia area is interested in financing the startup company and two financing plans have been put forth for consideration:

- The first (Plan A) is an all-in common-equity capital structure. $2.3 million dollars would be raised by selling common stock at $10 per common share.

- Plan B would involve the use of financial leverage. $1.4 million dollars would be raised by selling bonds with an effective interest rate of 10.6% (per annum), and the remaining $0.9 million would be raised by selling common stock at the $10 price per share. The use of financial leverage is considered to be a permanent part of the firms capitalization, so no fixed maturity date is needed for the analysis. A 30% tax rate is deemed appropriate for the analysis.

Question A: Find the EBIT indifference level associated with the two financing plans. (Round to the nearest dollar)

Question B: A detailed financial analysis of the firm's prospects suggests that the long-term EBIT will be

above $303,000 annually. Taking this into consideration, which plan will generate the higher EPS?

a. The EBIT indifference level associated with the two financing plans is $_. (round to the nearest dollar)
b. Using EBIT of $303,000, 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.)


B. Prepare a pro forma income statement for the EBIT level solved for in PART A that shows the EPS will be the same regardless whether Plan A or Plan B is chosen.

!stock Plan (A)I
EBIT----
Less: Interest Expense _
Earnings Before Taxes _ Less: Taxes at 30%----
Net Income _
Number of Common Shares _ EPS

Using EBIT of $303,000, 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 (B)I
EBIT _
Less: Interest Expense _ Earnings Before Taxes _
Less: Taxes at 30% ----
Net Income _
Number of Common Shares _ EPS _

The plan that will generate the higher EPS is Plan (A/B)?