Your client wishes to evaluate the possibility of an expansion of her husbands current business. A small group of boutique private investors are interested in providing finance with two differing structures. The first structure, plan A, is an all-ordinary-share capital structure. $5 million would be raised by selling 1 million shares at $5 each. The second structure, plan B, would involve the use of financial leverage. $1 million would be raised by issuing bonds with an effective interest rate of 7% (per annum). Under this plan, the remaining $4 million would be raised by selling 800,000 shares at $5 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: a) Find the EBIT indifference level associated with the two financing plans using an EBITEPS graph. Check your results algebraically. (10 marks)

b) A detailed financial analysis of the firms prospects suggests that the long-term EBIT will be $300,000 annually. Taking this into consideration, which plan will generate the higher EPS? (3 marks)