Question

Hale 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 200,000 shares of stock outstanding. Under Plan II, there would be 150,000 shares of stock outstanding and $2.2 million in debt outstanding. The interest rate on the debt is 5 percent and there are no taxes.

Hale 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 200,000 shares of stock outstanding. Under Plan II, there would be 150,000 shares of stock outstanding and $2.2 million in debt outstanding. The interest rate on the debt is 5 percent and there are no taxes. a. If EBIT is $350,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS $ Plan I Plan II b. If EBIT is $600,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS $ Plan I Plan II c. What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) Break-even EBIT

Answer 1

a.

	Plan I	Plan II
EBIT	350,000	350,000
less:interest on debt (2.2 m *5%)	nil	(110,000)
EBT	350,000	240,000
EPS (EBT / number of shares)	$1.75	$1.60

	EPS
Plan I	1.75
Plan II	1.60

b.

	Plan I	Plan II
EBIT	600,000	600,000
less:interest	nil	(110,000)
EBT	600,000	490,000
EPS (EBT / number of shares)	$3	$3.27

	EPS
Plan I	3
plan II	3.27

c.

working:

at break even EBIT = EPS is same for both the plans.

let x be the EBIT.

EPS of plan I = (x - interest) / number of shares

=> (x-0)/ 200,000

EPS of plan II = (x -110,000) / 150,000

so at break even point both EPS are equal

=> x/200,000 = (x-110,000) /150,000

=>0.75x = x-110,000

=>x=110,000/0.25

=>440,000.