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 320,000 shares of stock outstanding. Under Plan II, there would be 240,000 shares of stock outstanding and $2,272,000 in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.

a.	Assume that EBIT is $700,000. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
b.	Assume that EBIT is $950,000. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
c.	What is the break-even EBIT? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Answer 1

a. Under plan I, earnings per share is computed as shown below:

earnings per share = (EBIT - interest payment) / number of shares outstanding

earnings per share = ($ 700,000 - 0 ) / 320,000

earnings per share = $ 2.19 Approximately

Under plan II, earnings per share is:

earnings per share = ($ 700,000 - $ 2,272,000 x 10%) / 240,000

earnings per share = $ 1.97

b. Under plan I, earnings per share is computed as shown below:

earnings per share = (EBIT - interest payment) / number of shares outstanding

earnings per share = ($ 950,000 - 0 ) / 320,000

earnings per share = $ 2.97 Approximately

Under plan II, earnings per share is:

earnings per share = ($ 950,000 - $ 2,272,000 x 10%) / 240,000

earnings per share = $ 3.01 Approximately

c. The break-even EBIT is the level of earnings before interest such that the earnings per share is the same under the two plans:

(EBIT - 0) / 320,000 = (EBIT - $ 2,272,000 x 10%) / 240,000

EBIT = $ 908,800

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