Fin 370 Abe Forrester
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 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 2.3
million dollars would be raised by selling 88,000 common stock
Plan B would involve issuing 1.5 Million dollars in long
term bonds with an a effective interest rate of 12.2% plus $0.8 million would
be raised by selling 44,000 share of common stock. The debt funds raised under
plan B have no fixed maturity date, in that this amount of finance leverage is
considered a permanent part of the firms capital structure
ABE and his partners plan to use 35% 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 Plan B is chosen
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