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. 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 firms 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 ___________
