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(EBlT-EPS analysis) Four engineers from Martin-Bowing Company are leaving that firm in order to form their own corporation. The new firm will produce and distribute computer software on a national basis. "The software will be aimed at scientific markets and a.t businesses desiring to install comprehensive information systems. Private investors have been lined up to finance the new company. Two financing proposals are being studied. Both of these plans involve the use of some financial leverage; however, one is much more highly levered than the other. Plan A requires the firm to sell bonds with an effective interest rate of 14 percent. One million dollars would be raised in this manner. In addition, under plan A, $5 million would be raised by selling stock at $50 per common share. Plan B also involves raising $6 million. This would be accomplished by selling $3 million of bonds at an interest rate of 16 percent. The other $3 million would come from selling common stock at $50 per share. In both cases, the use of financial leverage is considered to be a permanent part of the firm's capital structure, so no fixed maturity date is used in the analysis. The firm considers a 50 percent tax rate appropriate for planning purposes.

1. Find the EBIT indifference level associated with the two financing plans, and prepare an EBIT-EPS analysis chart.
2. Prepare an analytical income statement that demonstrates that EPS will be same regardless of the plan selected. Use the EBIT level found in part (a) above.
3. A detailed financial analysis of the firm prospects suggest long-term EBIT will be above $1,188.000 annually. Taking this into consideration, which plan will generate the higher EPS?
4. Suppose that long-term EBIT is forecast to be $1,188,000 per year. Under plan A, a price/earnings ratio of 13 would apply. Under plan B, a price/earnings ratio of 11 would apply. If this set of financial relationships does hold, which financing plan would you recommend be implemented?
5. Again, assume an EBIT level of $1,188,000. What price/earnings ratio applied to the EPS of plan B would provide the same stock price as that projected for plan A? Refer to your data from part (d) above.