(EBIT-EPS analysis) A group of retired college professors has decided to form a small manufacturing corporation. The company will produce a full line of traditional office furniture. The investors have proposed two financing plans. Plan A is an all-common-equity alternative. Under this agreement, 2 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 $2 million. The corporate tax rate is 42 percent.
a. Find the EBIT indifference level associated with the two financing proposals.
b. Prepare an analytical 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 $2.3 million annually, which plan will provide for the higher EPS?