(EBIT-EPS analysis)

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 ofTennessee, Georgia, NorthCarolina, and South Carolina. A small group of private investors in theAtlanta, Georgia area is interested in financing the startup company and two financing plans have been put forth forconsideration:

The first(Plan A) is anall-common-equity capital structure.$2.0 million dollars would be raised by selling common stock at $20 per common share.

Plan B would involve the use of financial leverage.$1.0 million dollars would be raised by selling bonds with an effective interest rate of 11.0 percent(per annum), and the remaining $1.0 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 thefirm's capitalization, so no fixed maturity date is needed for the analysis. A 30 percent tax rate is deemed appropriate for the analysis.

a.Find the EBIT indifference level associated with the two financing plans.

b.A detailed financial analysis of thefirm's prospects suggests that thelong-term EBIT will be above $300,000 annually. Taking this intoconsideration, which plan will generate the higherEPS?