question 10 (EBIT-EPS analysis) Three recent graduates of the computer science program at the University of Tennessee are forming a company that will write and distribute new application software for the iPhone. Initially, the corporation will operate in the southern region of Tennessee, Georgia, North Carolina, and South Carolina. A small group of private investors in the Atlanta, Georgia area is interested in financing the startup company and two financing plans have been put forth for consideration: • The first (Plan A) is an all-common-equity capital structure. $2.5 million dollars would be raised by selling common stock at $20 per common share. • Plan B would involve the use of financial leverage. $1.1 million dollars would be raised by selling bonds with an effective interest rate of 10.6 percent (per annum), and the remaining $1.4 million would be raised by selling common stock at the $20 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalization, so no fixed maturity date is needed for the analysis. A 35 percent tax rate is deemed appropriate for the analysis. a. Find the EBIT indifference level associated with the two financing plans. b. A detailed financial analysis of the firm's prospects suggests that the long-term EBIT will be above $302,000 annually. Taking this into consideration, which plan will generate the higher EPS?

Entrepreneurial Finance

6th Edition

ISBN:9781337635653

Author:Leach

Publisher:Leach

Chapter1: Introduction To Finance For Entrepreneurs

Section: Chapter Questions

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question 10

(EBIT-EPS analysis) Three recent graduates of the computer science program at the University of Tennessee are forming a company that will write and distribute new application software for the iPhone. Initially, the corporation will operate in the southern region of Tennessee, Georgia, North Carolina, and South Carolina. A small group of private investors in the Atlanta, Georgia area is interested in financing the startup company and two financing plans have been put forth for consideration:

• The first (Plan A) is an all-common-equity capital structure.

$2.5 million dollars would be raised by selling common stock at $20 per common share.

• Plan B would involve the use of financial leverage.

$1.1 million dollars would be raised by selling bonds with an effective interest rate of 10.6

percent (per annum), and the remaining $1.4 million would be raised by selling common stock at the $20 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalization, so no fixed maturity date is needed for the analysis. A 35 percent tax rate is deemed appropriate for the analysis.

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

b. A detailed financial analysis of the firm's prospects suggests that the long-term EBIT will be above $302,000 annually. Taking this into consideration, which plan will generate the higher EPS?

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