You are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion.

The first (Plan A) is an all-ordinary-share capital structure. $10 million would be raised by selling 100,000 shares at $100 each.

Plan B would involve the use of financial leverage. $1 million would be raised issuing bonds with an effective interest rate of 10% (per annum). Under this second plan, the remaining $9 million would be raised by selling 90,000 shares at $100 price per share. The use of financial leverage is considered to be a permanent part of the firms capitalisation, so no fixed maturity date is needed for the analysis.

A 25% tax rate is appropriate for the analysis.

REQUIRED:

1. Find the EBIT indifference level associated with the two financing plans using an EBITEPS graph. Provide a check of your calculation to prove the EBIT indifference level. (5 marks)
2. A detailed financial analysis of the firms prospects suggests that the long-term earnings before interest and taxes (EBIT) will be $1,500,000 annually. Taking this into consideration, which plan will generate the higher earnings per share (EPS)? (2 marks)

Rather than EBIT, you are interested in other measures of risk associated with a project.

The basic values for your company is as follows:

Total Fixed Costs: $500,000

Price per unit: $18

Costs per unit: $14

3. What is the accounting break-even point? What does this number represent? (3 marks)