Reference no: EM13393104

1.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 $20 per common share.

Plan B would involve the use of financial leverage. $1.4 million dollars would be raised by selling bonds with an effect interest rate of 11.5% (per annum), and the remaining $0.9 million would be raised by selling common stock at the $20 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.

A detailed financial analysis of the firm’s prospects suggests that the long-term EBIT will be above $309,000 annually. Taking this into consideration, which plan will generate the higher EPS?

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)

EBIT ________
Less: Interest Expense ________
Earnings Before Taxes _________
Less: Taxes at 30% ________
Net Income _________
Number of Common Shares __________
EPS ___________

Bond/Stock Plan (B)

EBIT ________
Less: Interest Expense ________
Earnings Before Taxes _________
Less: Taxes at 30% ________
Net Income _________
Number of Common Shares __________
EPS ___________