Question

Trapper Corporation 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 160,000 shares of stock outstanding. Under Plan II, there would be 110,000 shares of stock outstanding and $1.4 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes. a. If EBIT is $400,000, 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 $650,000, 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?

Answer 1

a. If EBIT is $400,000, what is the EPS for each plan?

	Plan I	Plan II
	All Equity	Levered Plan
Share Outstanding	160000	110000
Debt	0	$1,400,000
EBIT	$400,000	$400,000
Less: Interest	0	98000
EBT (a)	$400,000	$302,000
No. of equity share (b)	160000	110000
EPS (a/b)	2.5	2.75

b. If EBIT is $650,000, what is the EPS for each plan?

	Plan I	Plan II
	All Equity	Levered Plan
Share Outstanding	160000	110000
Debt	0	$1,400,000
EBIT	$650,000	$650,000
Less: Interest	0	98000
EBT (a)	$650,000	$552,000
No. of equity share (b)	160000	110000
EPS (a/b)	4.06	5.02

c. What is the break-even EBIT?

$Break-Even EBIT \Rightarrow \frac{EBIT-I_{1}}{No. of equity shares under plan I} = \frac{EBIT-I_{2}}{No. of equity shares under plan II}$

Where

I_{1 =} Interest under Plan 1

I2 ₌ Interest under Plan II

$Break-Even EBIT \Rightarrow \frac{EBIT-0}{160000} = \frac{EBIT-\$98000}{110000}$

$Break-Even EBIT \Rightarrow 11EBIT =16EBIT-\$1568000$

$Break-Even EBIT \Rightarrow 5EBIT =\$1568000$

$Break-Even EBIT \Rightarrow \$313600$

I hope this clear your doubt.

Feel free to comment if you still have any query or need something else. I'll help asap.

Do give Thumbs up if you find this helpful.