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 190,000 shares of stock outstanding. Under Plan II, there would be 140,000 shares of stock outstanding and $2.8 million in debt outstanding. The interest rate on the debt is 6 percent, and there are no taxes.

  

a.	If EBIT is $275,000, 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 $525,000, 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

The computation is shown below:

As we know that

EPS = (EBIT - interest) * (1 - tax rate) / (number of shares)

a. The EPS for each plan is shown below:

For Plan I

= ($275,000 - 0) / (190,000 shares)

= $1.45 per share

For Plan II

= ($275,000 - $2,800,000 * 6%) / (140,000 shares)

= $0.76 per share

B. The EPS for each plan is shown below:

For Plan I

= ($525,000 - 0) / (190,000 shares)

= $2.76 per share

For Plan II

= ($525,000 - $2,800,000 * 6%) / (140,000 shares)

= $2.55 per share

C. Now the break even EBIT is

The break even EBIT is the EBIT of that amount where the EPS under the both plans is similar

I.e.

(EBIT/190,000) =,(EBIT- $2,800,000 * 6%) / (140,000)

So, EBIT = 638,400