Question

Round hammer is comparing two different capital structures: an all-equity plan (plan 1) and a levered plan (plan 2). Under plan 1, the company would have 205,000 shares of stock outstanding. Under plan 2, there would be 155,000 shares of stock outstanding and $3.1 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

A) 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)

B) if EBIT is $850,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places).

C) what is the break even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not in millions of dollars).

Answer 1

Answer to Part C)

At Break Even EBIT, EPS is same for both the plans.
EPS for Plan 1 = EPS for Plan 2
(EBIT – 0) / 205,000 = [(EBIT – 248,000)] / 155,000
EBIT / 205,000 = EBIT – 248,000 / 155,000
155,000 EBIT = 205,000 EBIT - $50,840,000,000
$50,840,000,000 = 50,000 EBIT
EBIT = $1,016,800

Therefore, Break Even EBIT is $1,016,800.