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General Energy Storage Systems General Energy Storage Systems (GESS) was founded in 2012 by Ian Redoks, a Ph.D. candidate in physics who was interested in “outside-the-box” solutions to the problem of storing electrical energy. Redoks had obtained several patents with potential applications for plug-in hybrid cars, off-grid home electrical systems, and large-scale storage of commercial electricity, produced by conventional means from excess capacity at off-peak hours or from non-fossil-fuel sources such as solar power and wind power. The timeliness of Redoks’s research has quickly attracted investors. For example, GESS has won contracts from an automobile company to manufacture batteries for a limited-production plug-in hybrid. It is also ready to begin commercial production of storage components for off-grid home electrical systems. More product means more storage space, however. To acquire the necessary manufacturing facilities, GESS needs to obtain additional financing. Up to this point, GESS’s primary source of funds had been form the sale of stock. The company is entirely equity-financed except for current liabilities incurred in the course of day-to-day operations. There are 250,000 shares outstanding, which are mostly owned by large, diverse technology companies that may wish to partner with or even acquire GESS at some point in the future. The shares trade occasionally in the NASDAQ over-the-counter market at an average price of $20.00. The investment bankers who placed the stock have suggested that an all-debt plan would minimize taxes, but it would be risky and leave little room for future borrowing. Instead, they recommend staying close to the industry averages for debt-to-assets and debt-to-equity ratios. They have proposed two alternative plans: a. Plan A calls for $2,000,000 of new equity (100,000 new shares at the firm’s current stock price of approximately $20.00) and $4,000,000 of privately placed debt at 7%. b. Plan B calls for $4,000,000 of new equity (200,000 new shares at the current stock price of $20.00) and $2,000,000 of privately placed debt at 6% Under either plan GESS’s combined state and federal marginal tax rate will be 28% 1. Which of the following is NOT a reason that GESS should expect to pay a higher rate of interest if it borrows $4,000,000 rather than $2,000,000? -A. Potential investors assume more risk by lending GESS more money for the same expected firm cash flow. -B. The U.S. Federal Reserve has just raised short-term interest rates by 0.25%. -C. GESS would have a lower EBIT coverage ratio borrowing a larger amount of money. - D. All of a, b and c are reasons GESS would pay a higher interest rate solely if it borrows $4,000,000 rather than $2,000,000. 10 points QUESTION 2. Estimate earnings per share for Plan A at $700,000 EBIT. Enter your answer with 2 decimals. For example enter 1.05 or 2.05, etc. 10 points QUESTION 3 Estimate earnings per share for Plan A at $1,000,000 EBIT. Enter your answer with 2 decimals. For example enter 1.05 or 2.05, etc. 10 points QUESTION 4 Estimate earnings per share for Plan A at $1,300,000 EBIT. Enter your answer with 2 decimals. For example enter 1.05 or 2.05, etc. 10 points QUESTION 5 Estimate earnings per share for Plan B at $700,000 EBIT. Enter your answer with 2 decimals. For example enter 1.05 or 2.05, etc. 10 points QUESTION 6 Estimate earnings per share for Plan B at $1,000,000 EBIT. Enter your answer with 2 decimals. For example enter 1.05 or 2.05, etc. 10 points QUESTION 7 Estimate earnings per share for Plan B at $1,300,000 EBIT. Enter your answer with 2 decimals. For example enter 1.05 or 2.05, etc. 10 points QUESTION 8 At what level of EBIT would EPS be the same under either plan? Enter the amount of EBIT in US$. Be careful with the magnitude of your answer (i.e. the answer should be between 700000 and 1300000) and round to the nearest whole dollar. 10 points QUESTION 9 Estimate the level of EPS for both plan A and plan B at the breakeven level of EBIT. Enter your answer with two decimals. For example enter 1.05, or 2.05, etc. 10 points QUESTION 10 Choose Yes or No - Suppose GESS’s management is fairly confident the EBIT will be at least $1,000,000. As a result, GESS management should choose plan A. Yes No