Question

Round Hammer is comparing two different capital structures: An all-equity plan (Plan 1) and a levered plan (Plan II). Under Plan 1, the company would have 185,000 shares of stock outstanding. Under Plan II, there would be 135,000 shares of stock outstanding and $2.7 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes. a. If EBIT is $375,000, 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 $625,000, 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.) Plan I EPS Plan II EPS Plan I EPS Plan II EPS Break-even EBIT

Answer 1

a)

Plan 1

EPS = EBIT*(1-tax rate)/shares = 375000*(1-0)/185000=2.03

Plan 2

EPS = (EBIT-debt*interest rate)*(1-tax rate)/shares = (375000-2700000*0.05)*(1-0)/135000=1.78

b)

Plan 1

EPS = EBIT*(1-tax rate)/shares = 625000*(1-0)/185000=3.38

Plan 2

EPS = (EBIT-debt*interest rate)*(1-tax rate)/shares = (625000-2700000*0.05)*(1-0)/135000=3.63

c)Break even EBIT is the EBIT where EPS plan I = EPS plan II

EBIT*(1-tax rate)/shares = (EBIT-interest rate*debt)*(1-tax rate)/shares

EBIT*(1-0)/185000=(EBIT-0.05*2700000)*(1-0)/135000

EBIT =499500