Question

Coldstream Corp. is comparing two different capital structures. Plan I would result in 12,000 shares of stock and $100,000 in debt. Plan II would result in 4,000 shares of stock and $200,000 in debt. The interest rate on the debt is 8 percent.

a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $70,000. The all-equity plan would result in 20,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

		EPS
Plan I	$
Plan II	$
All equity	$

b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.)

		EBIT
Plan I and all-equity	$
Plan II and all-equity	$

c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

EBIT           $

d-1 Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

		EPS
Plan I	$
Plan II	$
All equity	$

d-2 Assuming that the corporate tax rate is 40 percent, what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.)

		EBIT
Plan I and all-equity	$
Plan II and all-equity	$

d-3 Assuming that the corporate tax rate is 40 percent, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

EBIT           $

Answer 1

		Plan I	Plan II	All Equity
	No of Shares (i)	12,000	4,000	20,000
	Equity Capital $ (12.5/ Share) (ii)	150,000	50,000	250,000
	Debt (iii)	100,000	200,000	-
	Total Investment in the business (ii+iii)	250,000	250,000	250,000
a	EBIT	70,000	70,000	70,000
	Interset @ 8% on debt (iii*8%)	8,000	16,000	-
	EBT	62,000	54,000	70,000
	Tax (Ignored)	-	-	-
	EAT	62,000	54,000	70,000
	Earning Per Share (EAT/i)	5.17	13.50	3.50

b EBIT Level where EPS would be equal

Plan I and all-equity $ 20000

Plan II and all-equity $ 20000

b	EBIT	20,000	20,000	20,000
	Interset @ 8% on debt (iii*8%)	8,000	16,000	-
	EBT	12,000	4,000	20,000
	Tax (0%)	-	-	-
	EAT	12,000	4,000	20,000
	Earning Per Share (EAT/i)	1.00	1.00	1.00

c	What level of EBIT would give equal EPS for Plan 1 and II

(X-8000)/12000 = (X-16000)/4000

(X-8000)/3 = (X-16000)

X-8000 = 3X-48000

2X=40000

X = $ 20000 ( At a EBIT level of $ 20000, plan I and II would give equal EPS.

d-1	EBIT	70,000	70,000	70,000
	Interset @ 8% on debt (iii*8%)	8,000	16,000	-
	EBT	62,000	54,000	70,000
	Tax (40%)	24,800	21,600	28,000
	EAT	37,200	32,400	42,000
	Earning Per Share (EAT/i)	3.10	8.10	2.10

d-2 EBIT Level where EPS would be equal with Tax rate of 40%

Plan I and all-equity $ 20000

Plan II and all-equity $ 20000

d-2	EBIT	20,000	20,000	20,000
	Interset @ 8% on debt (iii*8%)	8,000	16,000	-
	EBT	12,000	4,000	20,000
	Tax (40%)	4,800	1,600	8,000
	EAT	7,200	2,400	12,000
	Earning Per Share (EAT/i)	0.60	0.60	0.60

d-3 EBIT Level where EPS would be equal with tax rate of 40% for Plans I and II is $ 20000