Question

EBIT—EPS and capital structure Data-Check is considering two capital structures. The key information is shown in the following table. Assume a 21% tax rate. Source of capital Long-term debt Common stock Structure A $90,000 at 15.6% coupon rate 4,500 shares Structure B $180,000 at 16.6% coupon rate 2,250 shares a. Calculate two EBIT-EPS coordinates for each of the structures by selecting any two EBIT values and finding their associated EPS values. b. Plot the two capital structures on a set of EBIT-EPS axes. c. Indicate over what EBIT range, if any, each structure is preferred. d. Discuss the leverage and risk aspects of each structure. e. If the firm is fairly certain that its EBIT will exceed $71,000, which structure would you recommend? Why? What if the tax rate was higher, say 40%? a. Calculate two EBIT-EPS coordinates for each of the structures by selecting any two EBIT values and finding their associated EPS values. Complete the tables below using $50,000 and $60,000 EBIT: (Round to the nearest dollar. Round the EPS to the nearest cent.)

The financial breakeven point for structure A is ?

​The financial breakeven point for structure B is ?

​(Round to the nearest​ dollar.)

Answer 1

Source of capital	Structure A	Structure B	Structure A	Structure B
long term debt	$90000 at 15.6% coupon rate	$180000 at 16.6% coupon rate	$90000 at 15.6% coupon rate	$180000 at 16.6% coupon rate
common stock	4500 shares	2250 shares	4500 shares	2250 shares
EBIT	50000	50000	60000	60000
Less:
Interest	90000*15.6%	180000*16.6%	90000*15.6%	180000*16.6%
Interest	14040	29880	14040	29880
EBT	35960	20120	45960	30120
Less: Tax 21%	7552	4225	9652	6325
PAT (EBT-TAX)	28408	15895	36308	23795
EPS (PAT /No of shares)	6.313	7.064	8.069	10.575
Structure "B" source of capital is good as the EPS is better in this case
IF EBIT IS $ 71000
Source of capital	Structure A	Structure B
long term debt	$90000 at 15.6% coupon rate	$180000 at 16.6% coupon rate
common stock	4500 shares	2250 shares
EBIT	71000	71000
Less:
Interest	90000*15.6%	180000*16.6%
Interest	14040	29880
EBT	56960	41120
Less: Tax 21%	11962	8635
PAT (EBT-TAX)	44998	32485
EPS (PAT /No of shares)	10.000	14.438
In this case also Structure "B" source of capital is good as the EPS is better in this case
IF EBIT IS $ 71000 & tax rate is 40%
Source of capital	Structure A	Structure B
long term debt	$90000 at 15.6% coupon rate	$180000 at 16.6% coupon rate
common stock	4500 shares	2250 shares
EBIT	71000	71000
Less:
Interest	90000*15.6%	180000*16.6%
Interest	14040	29880
EBT	56960	41120
Less: Tax 40%	22784	16448
PAT (EBT-TAX)	34176	24672
EPS (PAT /No of shares)	7.595	10.965
In this case also Structure "B" source of capital is good as the EPS is better in this case
As far as risk is concerned structure B is more leveraged
The financial breakeven point for structure A is ?	14040
The financial breakeven point for structure B is ?	29880