Question

Gerrell Corp. is considering a new capital structure. The new Levered Plan would result in 12,000 shares of stock and $100,000 in debt. The interest rate on the debt is 6 percent. Compare this plans to the current all-equity plan assuming that EBIT will be $75,000. The all-equity plan has 15,000 shares of stock outstanding. Assuming that the corporate tax rate is 40 percent, what is the EPS for each of these plans? What is the breakeven EBIT? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

15 EPS under the old All-Equity Plan = $______

16 EPS under the new Levered Plan = $______

17 What is the break-even level of EBIT for the Levered Plan as compared to the All-Equity Plan? (Do not round intermediate calculations.) Breakeven EBIT for Levered Plan and All-Equity Plan = $______

Answer 1

15. EPS is computed as shown below:

= [ EBIT x (1 - tax rate) ] / Number of shares outstanding

= [ $ 75,000 x (1 - 0.40) ] / 15,000

= $ 3

16. EPS is computed as shown below:

= [ (EBIT - interest expenses) x (1 - tax rate) ] / Number of shares outstanding

= [ ($ 75,000 - $ 100,000 x 6%) x (1 - 0.40) ] / 12,000

= $ 3.45

17. The break even level of EBIT is computed as follows:

= [ EBIT x (1 - tax rate) ] / Number of shares outstanding = [ (EBIT - interest expenses) x (1 - tax rate) ] / Number of shares outstanding

[ EBIT x (1 - 0.40) ] / 15,000 = [ (EBIT - $ 6,000) x (1 - 0.40) ] / 12,000

7,200 EBIT  = 9,000 EBIT - $ 54,000,000

EBIT = $ 30,000

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