Question

Round Hammer is comparing two different capital structures: An all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 180,000 shares of stock outstanding. Under Plan II, there would be 130,000 shares of stock outstanding and $2.6 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

  

a.	If EBIT is $575,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
b.	If EBIT is $825,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
c.	What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

     

Answer 1

Hi

a) Plan I EBIT = $575,000

since this all equity financed and no taxes

hence Net Income = EBIT = $575,000

EPS = 575,000/180,000 = $3.19

Plan II

EBIT= $575,000

interest = 2,600,00*8% = $208,000

Hence EPS = (575000-208000)/130000 = $2.82

b) Plan I

EPS = 825000/180000 = $4.58

Plan II

EPS = (825000 - 208000)/130000

= $4.75

c) breakeven EBIT between 2 plans are

EBIT/180000 = (EBIT-208000)/130000

0.72* EBIT = EBIT-208000

0.28* EBIT = 208000

EBIT = $748,800

hence breakeven EBIT is $748,800

Thanks