Question

Kolby Corp. is comparing two different capital structures. Plan I would result in 12,000 shares of stock and $100,000 in debt. Plan II would result in 4,000 shares of stock and $200,000 in debt. The interest rate on the debt is 8 percent.

  

a.

Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $70,000. The all-equity plan would result in 20,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	EPS
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? (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.)

  

	EBIT
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? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

EBIT

$

  

d-1.	Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	EPS
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? (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.)

  

	EBIT
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? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

EBIT

$

Answer 1

ANSWER:a

PLAN 1	PLAN 2	ALL EQUITY
EBIT 70,000	70000	70000
less : Interest (8000)	(16000)	-
EBT(A) 62000	54000	70000
No of shares (B) 12000	4000	20000
EPS(A/B) 5.17	13.50	3.50

Note: interest @ 8% has been taken on debenture amount for calculation of interest .

Above solution is before considering taxes hece EBT has been divided to no of shares for calculation of EPS because EAT (earning after tax) & earning before tax will be same as taxes have to be ignored.