(Related to Checkpoint15.2)

(EBIT-EPS analysis)Abe Forrester and three of his friends from college have interested a group of venture capitalists in backing their business idea. The proposed operation would consist of a series of retail outlets to distribute and service a full line of vacuum cleaners and accessories. These stores would be located inDallas, Houston, and San Antonio. To finance the new venture two plans have beenproposed:

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Plan A is anall-common-equity structure in which $2.5 million dollars would be raised by selling 88,000 shares of common stock.

Plan B would involve issuing $1.4 million inlong-term bonds with an effective interest rate of 11.8% plus another $1.1 million would be raised by selling 44,000 shares of common stock. The debt funds raised under Plan B have no fixed maturitydate, in that this amount of financial leverage is considered a permanent part of thefirm's capital structure.

Abe and his partners plan to use a 35% tax rate in theiranalysis, and they have hired you on a consulting basis to do thefollowing:

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

b.Prepare a pro forma income statement for the EBIT level solved for in part a that shows that EPS will be the same regardless whether Plan A or B is chosen.

I have attached the layout of the questions.

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