​EBIT-EPS analysis

(​EBIT-EPS analysis​) A group of retired college professors has decided to form a small manufacturing corporation that will produce a full line of traditional office furniture.

The investors have proposed two financing plans:

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Plan A is an​ all-common-equity alternative. Under this​ agreement, 1.6 million common shares will be sold to net the firm $10 per share.

Plan B involves the use of financial leverage. A debt issue with a​ 20-year maturity period will be privately placed. The debt issue will carry an interest rate of 9 ​percent, and the principal borrowed will amount to ​$1.6 million. The marginal corporate tax rate is 25 percent.

a. Find the EBIT indifference level associated with the two financing proposals.

b. Prepare a pro forma income statement that proves EPS will be the same regardless of the plan chosen at the EBIT level found in part a.

c. Prepare an​ EBIT-EPS analysis chart for this situation.

d. If a detailed financial analysis projects that​ long-term EBIT will always be close to ​$1.94 million​ annually, which plan will provide for the higher​ EPS?

e. If you were to present the results of your analysis found in part a through d​, how would you summarize your findings to your​ employer?

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