Roberts, Inc

question 6

Essay

Roberts, Inc. is trying to decide how best to finance a proposed $10 million capital investment. Under Plan I, the project will be financed entirely with long-term 9% bonds. The firm currently has no debt or preferred stock. Under Plan II, common stock will be sold to net the firm $20 a share; presently, 1 million shares are outstanding. The corporate tax rate for Roberts is 40%.
a. Calculate the indifference level of EBIT associated with the two financing plans.
b. Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why?
c. If EBIT is expected to be $3.1 million, which plan will result in a higher EPS?

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Definitions:

Unrealized Gains and Losses

Profits or losses that arise from changes in the value of investments or assets that have not yet been sold or realized.

Other Comprehensive Income

A component of shareholders' equity, consisting of income that is not realized and hence not included in the net income (loss), such as unrealized gains or losses on available-for-sale securities.

GAAP

Generally Accepted Accounting Principles, which are a set of rules and standards for financial reporting used in the United States.

Amortized Cost

The progressive reduction of a debt or the cost of an intangible asset over a specified time period.