Plan A is an all-common equity structure in which $2.2 million dollars would be raised by selling 82,000 shares of common stock.
Plan B would involve issuing $1.3 million dollars in long-term bonds with an effective interest rate of 11.5% plus $0.9 million would be raised by selling 41,000 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. Tax rate is 34%.
a. Find the EBIT difference level associated with the two financing plans.
b. Prepare a pro forma income statement for the EBIT level in part a. that shows that EPS will be the same regardless whether Plan A or B is chosen.
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