Question

EBITlong dash—EPS

and capital structure????Data-Check is considering two capital structures. The key information is shown in the following table. Assume a

40 %40%

tax rate.

Source of capital	Structure A	Structure B
?Long-term debt	$97,000 at 15.2% coupon rate	$194,000 at 16.2% coupon rate
Common stock	4,600 shares	2,300 shares

a. Calculate two ?EBIT-EPS coordinates for each of the structures by selecting any two EBIT values and finding their associated EPS values.

b. Plot the two capital structures on a set of? EBIT-EPS axes.

c. Indicate over what EBIT? range, if? any, each structure is preferred.

d. Discuss the leverage and risk aspects of each structure.

e. If the firm is fairly certain that its EBIT will exceed $78,000?,

which structure would you? recommend? Why?

A.  

Structure A

EBIT $ 50,000

Less: Interest $

Net profits before taxes $

Less: Taxes $

Net profit after taxes $

EPS (4,600 shares) $

Answer 1

	A	B
EBIT	$ 50,000.00	$ 50,000.00
Interest	$ 14,744.00	$ 31,428.00
EBT	$ 35,256.00	$ 18,572.00
Tax (40%)	$ 14,102.40	$   7,428.80
Net Profits	$ 21,153.60	$ 11,143.20
EPS	$          4.60	$          4.84

Interest = Debt x Interest Rate

Tax = 40% x EBT

EPS = Net Profits / No. of shares

	A	B
EBIT	$ 40,000.00	$ 40,000.00
Interest	$ 14,744.00	$ 31,428.00
EBT	$ 25,256.00	$   8,572.00
Tax (40%)	$ 10,102.40	$   3,428.80
Net Profits	$ 15,153.60	$   5,143.20
EPS	$          3.29	$          2.24

If the firm is certain that the EBIT > 78,000, Structure B is recommended as its EPS would be higher than that for A.