Question

Destin Corp. is comparing two different capital structures. Plan-I would result in 10,000 shares of stock and $90,000 in debt. Plan II would result in 7, 600 shares of stock and $198,000 in debt. The interest rate on the debt is 10 percent.

A. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $48,000. The all-equity plan would result in 12,000 shares of stock outstanding. What is the EPS for each of these plans?

Plan I =
Plan II =
All equity =

B. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan?

Plan I and All equity=

Plan II and All equity=

C. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II?

EBIT=

D-1. Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Round your answers to 2 decimal places. (e.g., 32.16))

Plan I =
Plan II =
All equity =

D-2. Assuming that the corporate tax rate is 40 percent, what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan?

Plan I and All equity=

Plan II and All equity=

D.3. Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II?

EBIT=

Answer 1

Answer to Part B.

At Break Even EBIT, EPS will be equal to each other in both options.

Plan I and All Equity:

At Break Even EBIT, EPS will be equal to each other in both options.

Therefore,
(EBIT – 9,000) / 10,000 = (EBIT – 0) / 12,000
12,000 (EBIT – 9,000) = 10,000 (EBIT – 0)
12,000 EBIT - 108,000,000 = 10,000 EBIT
2,000 EBIT = 108,000,000
EBIT = $54,000

Plan II and All Equity:

At Break Even EBIT, EPS will be equal to each other in both options.

Therefore,
(EBIT – 19,800) / 7,600 = (EBIT – 0) / 12,000
12,000 (EBIT – 19,800) = 7,600 (EBIT – 0)
12,000 EBIT - 237,600,000 = 7,600 EBIT
4,400 EBIT = 237,600,000
EBIT = $54,000

Answer to Part C.

EPS for Plan I = EPS for Plan II
(EBIT – 9,000) / 10,000 = (EBIT – 19,800) / 7,600
7,600 * (EBIT – 9,000) = 10,000 * (EBIT – 19,800)
7,600 EBIT - $68,400,000 = 10,000 EBIT - $198,000,000
2,400 EBIT = $129,600,000
EBIT = $54,000

Answer to Part D-2.

At Break Even EBIT, EPS will be equal to each other in both options.

Plan I and All Equity:

At Break Even EBIT, EPS will be equal to each other in both options.

Therefore,
[(EBIT – 9,000) * (1 – 0.40)] / 10,000 = [(EBIT – 0)* (1-0.40)] / 12,000
[(EBIT – 9,000) * 0.60] / 10,000 = [(EBIT – 0)* 0.60] / 12,000
0.60 EBIT – 5,400 / 10,000 = 0.60 EBIT / 12,000
12,000 (0.60 EBIT – 5,400) = 10,000 (0.60 EBIT)
7,200 EBIT - $64,800,000 = 6,000 EBIT

1,200 EBIT = $64,800,000
EBIT = $54,000

Plan II and All Equity:

At Break Even EBIT, EPS will be equal to each other in both options.

Therefore,
[(EBIT – 19,800) * (1 – 0.40)] / 7,600 = [(EBIT – 0)* (1-0.40)] / 12,000
[(EBIT – 19,800) * 0.60] / 7,600 = [(EBIT – 0)* 0.60] / 12,000
0.60 EBIT – 11,880 / 7,600 = 0.60 EBIT / 12,000
12,000 (0.60 EBIT – 11,880) = 7,600 (0.60 EBIT)
7,200 EBIT - $142,560,000 = 4,560 EBIT
2,640 EBIT = $142,560,000
EBIT = $54,000

Answer to Part D-3.

EPS for Plan I = EPS for Plan II
[(EBIT – 9,000) * (1 – 0.40)] / 10,000 = [(EBIT – 19,800) * (1 – 0.40)] / 7,600
[(EBIT – 9,000) * 0.60] / 10,000 = [(EBIT – 19,800) * 0.60] / 7,600
[0.60 EBIT – 5,400] / 10,000 = [0.60 EBIT – 11,880] / 7,600
7,600 * [0.60 EBIT – 5,400] = 10,000 * [0.60 EBIT – 11,880]
4,560 EBIT - $41,040,000 = 6,000 EBIT - $118,800,000
1,440 EBIT = 77,760,000
EBIT = $54,000