16-4B. (ERIT-EPS analysis) Three recent liberal arts graduates have interested a group of venmre capitalists in backing a new business enterprise. The proposed operation would consist ofa series of retail outlets to distribute and service a full line of personal computer equipment. These stores would be located in Texas, Arizona, and New Mexico. Two financing plans have been proposed by the graduates. Plan A is an all-common-equity structure. Four million dollars would be raised by selling 80,000 shares of common stock. Plan B would involve the use oflong-term debt financing. Two million dollars would be raised by marketing bonds with an effective interestrate of 16 percent. Under this alternative, another $2 million would be raised by selling 50,000 shares of common stock. "\Vith both plans, then, $4 million is needed to launch the new firm's operations.

The debt funds raised under plan B are considered to have no fixed mamrity date, in that this proportion of financial leverage is thought to be a permanent part of the company's capital strucmre. The fledgling executives have decided to use a 34 percent 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 proposals.

b. Prepare an analytical income statement that proves EPS will be the same regardless of the plan chosen at the EBIT level found in part

(a) above.