Question

Trapper Corporation 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

a)

EPS formula = (net income - preferred stock dividends) / weighted average outstanding stocks

Earnings per share (EPS) for Plan I:

EPS = $575,000 / 180,000 = $3.319 per share

Earnings per share (EPS) for Plan II:

net income = EBIT - interests = $575,000 - $208,000 = $367,000

EPS = $367,000 / 130,000 = $2.82 per share

b)

Earnings per share (EPS) for Plan I:

EPS = $825,000 / 180,000 = $4.58 per share

Earnings per share (EPS) for Plan II:

net income = EBIT - interests = $825,000 - $208,000 = $617,000

EPS = $617,000 / 130,000 = $4.75 per share

c)

Denote the break-even EBIT as x.

At break-even EBIT, EPS will be the same for two structures.

=> x/180,000 = (x - 2,600,000 x 8%)/ 130,000

<=> 13x / 18 = x - 208,000

<=> 2,08,000 = 5x/18

<=> x = 208,000 x 18/5

= $748,800.

please appreciate the work