Question

5. A firm is considering financing its $20 million dollars of assets with one of two plans. Plan A consists of $3 million of debt with an interest rate of 6.6%, and 1.7 million shares of common stock. Plan B consists of $10 million dollars in debt with an interest rate of 7.2%, and 1 million shares of common stock. The firm's tax rate is 30%. Calculate the EBIT-EPS breakeven point, and then calculate the earnings per share at this level of EBIT.

Answer 1

EPS = (EBIT-I)*(1-Tax rate)/N where I = interest expense and N = number of shares outstanding

For the break-even point, EPS under both capital structures has to be equal.

(EBIT - 6.6%*3,000,000)*(1-30%)/1.7 = (EBIT - 7.2%*10,000,000)*(1-30%)/1

EBIT - 198,000 = 1.7*(EBIT - 720,000)

EBIT - 198,000 = 1.7EBIT - 1,224,000

0.7EBIT = 1,026,000

EBIT = 1,465,714.29

EPS at this EBIT = (1,465,714.29 - 720,000)*(1-30%)/1,000,000 = $0.522 per share