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 185,000 shares of stock outstanding. Under Plan II, there would be 135,000 shares of stock outstanding and $1.9 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes. a. If EBIT is $425,000, 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 $675,000, 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

	Plan I	Plan II
EBIT	425,000	425,000
Less: Interest	0	133,000
EBT	425,000	292,000
Less: Taxes	0	0
Net Income	425,000	292,000
Number of shares	185,000	135,000
EPS	2.2973	2.163
b.
	Plan I	Plan II
EBIT	675,000	675,000
Less: Interest	0	133,000
EBT	675,000	542,000
Less: Taxes	0	0
Net Income	675,000	542,000
Number of shares	185,000	135,000
EPS	3.6486	4.0148
Break even EBIT is the point at which EPS under both plans is same
Let it be x
x/185000 = (x-133000)/135000
x = 492,100
i.e. $492,100