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...


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

Extracted 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.

Jun 08, 2022
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