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 150,000 shares of stock outstanding. Under Plan II, there would be 100,000 shares of stock outstanding and $1.2 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes. a. If EBIT is $300,000, 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 $550,000, 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

Plan I:

Number of shares outstanding = 150,000

Plan II:

Number of shares outstanding = 100,000
Value of Debt = $1,200,000

Interest Expense = 5% * $1,200,000
Interest Expense = $60,000

Answer a.

$ Planl 300,000 $ IS 300,000 $ Plan II 300,000 60,000 240,000 EBIT Less: Interest EBT Less: Taxes Net Income # of Shares 300,000 $ 150,000 2.00 $ 240,000 100,000 2.40 EPS $

Answer b.

Plan! 550,000 $ EBIT Plan II 550,000 60,000 490,000 550,000 $ Less: Interest EBT Less: Taxes Net Income # of Shares EPS 550,000 $ 150,000 3.67 $ 490,000 100,000 4.90 $

Answer c.

Let Breakeven EBIT be $x

Plan I:

EPS = (EBIT - Interest Expense) / Number of shares outstanding
EPS = ($x - $0) / 150,000

Plan II:

EPS = (EBIT - Interest Expense) / Number of shares outstanding
EPS = ($x - $60,000) / 100,000

EPS under Plan II and EPS under Plan I
($x - $60,000) / 100,000 = ($x - $0) / 150,000
3 * $x - $180,000 = 2 * $x
$x = $180,000

Breakeven EBIT is $180,000