Three recent graduates of the computer science program at the University of Tennessee are forming a company that will write and distribute new application software for the iPhone. Initially, the corporation will operate in the southern region of Tennessee, Georgia, North Carolina and South Carolina. A small group of private investors in the Atlanta, Georgia are interested in financing the startup company and two financing plans have been put forth into consideration.The first plan(A) is an all common equity capital structure $2.2 million dollars would be raised by selling common stock at $10 per common share. Plan B would involve the use of financial leverage. $1.5 million would be raised by selling bonds with an effective interest rate of 11.2% and the remaining 0.7 mill would be raised by selling common stock at the $10 price per share. The use of financial leverage is considered to be a permanent part of the firms capitalization, so no fixed date is needed for the analysis. A 30% tax rate is deemed appropriate for the analysis.
a. Find the EBIT indifference level associated with the two financing plans.
b. A detailed financial analysis of the firms prospects suggests that the long-term EBIT will be above $305,000 annually. Taking this into consideration which plan will generate the higher EPS?
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