(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:

Bullet

• Plan A is an?all-common-equity structure in which $2.5million dollars would be raised by selling88,000shares of common stock.
• Plan B would involve issuing ?$1.4million in?long-term bonds with an effective interest rate of11.8% plus another $1.1 million would be raised by selling44,000shares 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 35% 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.