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You are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion. The first (Plan A) is an all-ordinary-share capital structure. $1 million would be raised by selling 250,000 shares at $4 each. Plan B would involve the use of financial leverage. $700,000 would be raised issuing bonds with an effective interest rate of 13% (per annum). Under this second plan, the remaining $300,000 would be raised by selling 75,000 shares at $4 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalisation, so no fixed maturity date is needed for the analysis. A 30% tax rate is appropriate for the analysis.

You are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion. The first (Plan A) is an all-ordinary-share capital structure. $1 million would be raised by selling 250,000 shares at $4 each. Plan B would involve the use of financial leverage. $700,000 would be raised issuing bonds with an effective interest rate of 13% (per annum). Under this second plan, the remaining $300,000 would be raised by selling 75,000 shares at $4 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalisation, so no fixed maturity date is needed for the analysis. A 30% tax rate is appropriate for the analysis.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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You are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion. The first (Plan A) is an all-ordinary-share capital structure. $1 million would be raised by selling 250,000 shares at $4 each. Plan B would involve the use of financial leverage. $700,000 would be raised issuing bonds with an effective interest rate of 13% (per annum). Under this second plan, the remaining $300,000 would be raised by selling 75,000 shares at $4 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalisation, so no fixed maturity date is needed for the analysis. A 30% tax rate is appropriate for the analysis. REQUIRED: a) Find the EBIT indifference level associated with the two financing plans using an EBIT-EPS graph. Check your results algebraically. b) A detailed financial analysis of the firm's prospects suggests that the long-term earnings before interest and taxes (EBIT) will be $110,000 annually. Taking this into consideration, which plan will generate the higher earnings per share (EPS)? c) Briefly explain the primary weakness of EBIT-EPS analysis as a financing decision tool.
Transcribed Image Text:You are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion. The first (Plan A) is an all-ordinary-share capital structure. $1 million would be raised by selling 250,000 shares at $4 each. Plan B would involve the use of financial leverage. $700,000 would be raised issuing bonds with an effective interest rate of 13% (per annum). Under this second plan, the remaining $300,000 would be raised by selling 75,000 shares at $4 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalisation, so no fixed maturity date is needed for the analysis. A 30% tax rate is appropriate for the analysis. REQUIRED: a) Find the EBIT indifference level associated with the two financing plans using an EBIT-EPS graph. Check your results algebraically. b) A detailed financial analysis of the firm's prospects suggests that the long-term earnings before interest and taxes (EBIT) will be $110,000 annually. Taking this into consideration, which plan will generate the higher earnings per share (EPS)? c) Briefly explain the primary weakness of EBIT-EPS analysis as a financing decision tool.
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