[tania7120]

I am having an issue solving and catching on to a finance homework question. I have part of it done but am having issues on where to find certain numbers. Here is the question and what I have thus far.


Abe Forrester and three
Of his friends from college have interested a group of venture capitalists in backing their
Business idea. The proposed operation would consist of a series of retail outlets to
Distribute and service a full line of vacuum cleaners and accessories. These stores would
Be located in Dallas, Houston, and San Antonio. To finance the new venture two plans
Have been proposed:
• Plan A is an all-common-equity structure in which $2 million dollars would be raised
By selling 80,000 shares of common stock.
• Plan B would involve issuing $1 million dollars in long-term bonds with an effective
Interest rate of 12% plus another $1 million would be raised by selling 40,000 shares
Of common stock. The debt funds raised under Plan B have no fixed maturity date, in
That this amount of financial leverage is considered a permanent part of the firm's
Capital structure.
Abe and his partners plan to use a 40% tax rate in their analysis, and they have hired
You on a consulting basis to do the following:
A. Find the EBIT indifference level associated with the two financing plans.

(EBIT-0)*(1-40%) = (EBIT-?)*(1-40%)
80,000 40,000

I am having an issue on where the information is that I put the ? Mark down for. I need some what detail as I do need to understand how to do it!

[ArcSine]

You're nearly there. Since Plan B calls for 1M in bonds with an interest rate of 12%, the total interest expense (and hence the value for your "?") is 1,000,000 x 0.12 = 120,000.

You can take it from there. You'll need to find a value for EBIT at which that equality is true. Check back in and let me know what you came up with for the EBIT indiff point.

[lovelytilltheen]

What I don't get is how you get X or the ebit.

[lovelytilltheen]

You're nearly there. Since Plan B calls for 1M in bonds with an interest rate of 12%, the total interest expense (and hence the value for your "?") is 1,000,000 x 0.12 = 120,000.

You can take it from there. You'll need to find a value for EBIT at which that equality is true. Check back in and let me know what you came up with for the EBIT indiff point.

I am in this class now an I am completely confused.