Ebit indifference level associated with the two financing plans

 

(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. Two million dollars would be raised by selling common stock at $20 per common share.
  • Plan B would involve the use of financial leverage. One million dollars would be raised by selling bonds with an effective interest rate of 11% (per annum), and the remaining $1 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 30% tax rate is deemed appropriate for the analysis.
  1. Find the EBIT indifference level associated with the two financing plans.
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