Mother Earth Inc. (MEI) was started three years ago by two friends who recently graduated from Blue Rock College. MEI, a multimillion-dollar distributor of environmentally friendly products, currently sells products made by other manufacturers. The management team is now considering the purchase of the manufacturer of MEIs bestselling product. The acquisition is expected to cost $12,000,000, but MEIs chief financial officer (CFO) is unclear as to whether the purchase should be financed using debt or equity funds.

MEIs current capital structure consists of 1,000,000 shares of common stock and a $4 million term loan. The interest rate on the loan is 4%, and MEIs tax rate is 40%. The two financing alternatives are:

	Plan 1 Common equity financing: Sell an additional 750,000 shares at $16 per share.
	Plan 2 Debt financing: Secure $12,000,000 through a four-year 9% term loan.

MEIs current earnings before interest and taxes (EBIT) is $15,000,000, and is expected to increase to $20,000,000.

Given MEIs current situation and acquisition plans, complete the following table:

Current earnings per share (EPS) ___________?
Expected EPS under Plan 1 Common equity financing ____________?
Expected EPS under Plan 2 Debt financing ____________?

MEIs EBIT-EPS indifference point for the debt and equity financing plans occurs when its EBIT is ____________? and its EPS is ________________?

When the firms expected EBIT exceeds its EBIT-EPS indifference point and its capital structure contains increasing levels of _____________? financing, the firms EPS will increase. At the same time, the firms financial risk will ____________? .

Assuming that MEI realizes an EBIT of $8,650,000, all other things being equal, which plan should you recommend?

Plan 1

Plan 2

Either plan

Neither plan

The times-interest-earned (TIE) ratio often serves as an indicator of the firms ability to __________________________________ . Prior to its acquisition, the firms TIE ratio is _______________________ ; however, if MEI makes the acquisition and finances it using Plan 2, by securing additional debt capital, then the firms TIE ratio will decrease to 16.13.