Abe Forrester and three of his friends from college have interested a group of venture capitalist in backing their business idea. The proposed operation would consist of a series of retail outlets to distribute and service full line of vacuum cleaners and accessories. These stores would be located in Dallas, Houston, and San Antonio. To finance the new venture two plans have been proposed:
- Plan A is an all common equity structure in which $2.2 million dollars would be raised by selling 86,000 shares of common stock.
- Plan B would involve issuing $1.1 million dollars in long –term bonds with an effective interest rate of 12.5% plus $1.1 million would be raised by selling 43,000 shares of common stock. The debt funds raised under Plan B have no fixed maturity date, in that this amount of financial leverage is considered a permanent part of the firm’s capital structure.
Abe and his partners plan to use a 38% tax rate in their analysis, and they have hired you on a consulting basis to do the following:
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.




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