Question

Coldstream Corp. is comparing two different capital structures. Plan I would result in 16,000 shares of stock and $100,000 in debt. Plan II would result in 12,000 shares of stock and $200,000 in debt. The interest rate on the debt is 6 percent. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $80,000. The all-equity plan would result in 20,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I $ Plan II $ All equity $ b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT Plan I and all-equity $ Plan II and all-equity $ c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.) EBIT $ d-1 Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I $ Plan II $ All equity $ d-2 Assuming that the corporate tax rate is 40 percent, what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT Plan I and all-equity $ Plan II and all-equity $ d-3 Assuming that the corporate tax rate is 40 percent, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.) EBIT

Answer 1

Question - a

EPS of each of the plans

	Plan - 1	Plan-II	All equity
EPS	4.63	5.67	4

EPS = (EBIT - Interest) / Number of shares. For Plan - I ..... (80000 - 6000) / 16000 = 4.63, For plan - II we have ........ (80000 - 12000) / 12000 = 5.67 and All equity = 80000 / 20000 = 4

Question - b

	Plan - I and All equity	Plan - II and All equity
EBIT	30000	30000

Break even level of EBIT of PLAN - I with All equity

( X - 6000) / 16000 = ( x - 0 ) / 20000

X - 6000 = X * 16/20

X - 0.80 X = 6000

X = 6000 / 0.20 = $ 30000

Break even level of EBIT of PLAN - II with All equity

( X - 12000) / 12000 = ( x - 0 ) / 20000

X - 12000 = X * 12/20

X - 0.60 X = 12000

X = 12000 / 0.40 = $ 30000

Question - c

Level of EBIT forl EPS be identical for Plans I and II

( X - 6000) / 16000 = (X - 12000) / 12000

X - 6000 = 16/12 * X - 16000

1/3 X = 10000

X = $ 30000

Question - d

d1 ............ EPS with tax rate of 40%

	Plan - 1	Plan-II	All equity
EPS	2.78	3.4	2.4

For Plan - I ..... (80000 - 6000) *0.60 / 16000 = 4.63, For plan - II we have ........ (80000 - 12000)*0.60 / 12000 = 5.67 and All equity = 80000 / 20000 = 4

Question - d2

	Plan - I and All equity	Plan - II and All equity
EBIT	30000	30000

Note ........ Existence of tax does not effect the Break even point. Since ( 1 - tax rate ) = 0.60 will be cancelled on eithersides in solving the equations. ( refer to equations in question - b above)

Question - d3

Level of EBIT forl EPS be identical for Plans I and II

( X - 6000) * ( 1 - 0.40) / 16000 = (X - 12000) * (1 - 0.40) / 12000

When ( 1 - 0.40 ) gets cancelled on either sides

( X - 6000) / 16000 = (X - 12000) / 12000

X - 6000 = 16/12 * X - 16000

1/3 X = 10000

X = $ 30000