Abe Forrester and three of his friends from college have interested a group of venture capitalists in backing their business…
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 2.3 million dollars would be raised by selling 84,000 shares of common stock. Plan B would involve issuing 1.1 million dollars in long term bonds with an effective interest rate of 11.7% plus a 1.2 million would be raised by selling 42,000 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 firms capital structure. Abe and his partners plan to use a 40% 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 Plan B is chosen
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