Question

Section B Question 1 (Show all workings/steps) (10 marks) wa Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a revered plan (Plan II). Under Plan I, the company would have 195,000 shares of stock outstanding. Under Plan II, there would be 100,000 shares of stock outstanding and $1,787,500 in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes. a. If EBIT is $400,000, which plan will result in the higher EPS? b. If EBIT is $600,000, which plan will result in the higher EPS? c. What is the break-even EBIT?

Answer 1

Solution Plan 400,000 Parta: EBIT Less: Interest =1787500* 10% net income shares outstanding EPS Plan Il results in higher EPS Plan Il 400,000 178,750 221,250 100,000 2.21 400,000 195,000 2.05 Plan 600,000 Part b: EBIT Less: Interest =1787500* 10% net income / shares outstanding EPS Plan ll results in higher EPS Plan II 600,000 178,750 421,250 100,000 4.21 600,000 195,000 3.08 Part: Breakeven EBIT for Plan and Plan II let the break even EBIT be a a/195000={a-178750)/100000 a/195={a-178750)/100 100 a=1952-34856250 195a-100 a=34856250 95a=34856250 a=34856250/95 366,908