Question
LA Sports Inc. needs to raise $500 million in capital to finance an expansion. A team in the treasury department is working on a financing
LA Sports Inc. needs to raise $500 million in capital to finance an expansion. A team in the treasury department is working on a financing proposal and is considering the following two alternative financing plans.
Plan 1: All equity financing with the new common shares issued at $20 per share.
Plan 2: 40/60 financing plan with
40% financed through the issuance of new corporate bonds at 10% interest rate and
60% financed through the issuance of new common shares at $25 per share.
The firms CURRENT capital structure consists of both equity and debt/corporate bond.
It currently has 30 million common shares outstanding.
The total principal amount of outstanding corporate bond is 200 million and the coupon rate is 9%.
LA Sports Inc. is in the 21 percent corporate tax bracket.
(1) Calculate indifference EBIT.
(2) Calculate indifference EPS.
(3) If the project is expected to generate $100 million EBIT, which plan would you recommend?
A. Plan 1
B. Plan 2
(4) Compare these two financing plans, which plan might send out a stronger positive signal and result in a more favorable market reaction upon the announcement? Assume there are no other corporate announcements.
A. Plan 1
B. Plan 2
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