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 170,000 shares of stock outstanding. Under Plan II, there would be 120,000 shares of stock outstanding and $1.6 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes. a. 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.) b. If EBIT is $775,000, 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	525000	525000
Less: Interest	0	128000
EBT	525000	397000
Less: Taxes	0	0
Net Income	525000	397000
Number of Shares	170000	120000
EPS	3.09	3.31
b.
	Plan I	Plan II
EBIT	775000	775000
Less: Interest	0	128000
EBT	775000	647000
Less: Taxes	0	0
Net Income	775000	647000
Number of Shares	170000	120000
EPS	4.56	5.39
Break even EBIT will be the point at which EPS under both plans is same
Let it be x
x/170000 = (x-128000)/120000
120000x = (x-128000)*170000
x = 435200
Hence, Break even EBIT = $435,200