Three graduates are forming a company that write and distribute new application software for the IPhone. Initially, the corporation will operate in the southern region of tennessee, georgia and n. carolina. A small group of private invesors in Atlanta are interested in financing the start-up company and 2 financing plans have been presented for consideration:
the first plan: is an all-common equity capital structure. $2.1 million would be raised by selling common stock at $20 per common share.
Plan B: would involve the use of financial leverage. $1.1 million would be raised by selling bonds with an effective interest rate of 11.1% (per annum), and the remaining $1.0 million would be raised by selling common stock at $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 34% 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 prospectus suggests that the long-term EBIT will be above $332,000 annually. Taking this into consideration, which plan will generate the higher EPS?