Question

Haskell Corp. is comparing two different capital structures. Plan I would result in 12,000 shares of stock and $100,000 in debt. Plan II would result in 4,000 shares of stock and $200,000 in debt. The interest rate on the debt is 8 percent. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $70,000. 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, when will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

Answer 1

Plan I:

Number of shares = 12,000
Value of Debt = $100,000

Interest Expense = 8% * $100,000
Interest Expense = $8,000

Plan II:

Number of shares = 4,000
Value of Debt = $200,000

Interest Expense = 8% * $200,000
Interest Expense = $16,000

All Equity Plan:

Number of shares = 20,000

Answer a.

Answer b.

Plan I and All Equity Plan:

Let breakeven EBIT be $x

Plan I:

EPS = (EBIT - Interest) / Number of shares
EPS = ($x - $8,000) / 12,000

All Equity Plan:

EPS = (EBIT - Interest) / Number of shares
EPS = ($x - $0) / 20,000

EPS under Plan I = EPS under All Equity Plan
($x - $8,000) / 12,000 = ($x - $0) / 20,000
5 * $x - $40,000 = 3 * $x
2 * $x = $40,000
$x = $20,000

Breakeven EBIT = $20,000

Plan II and All Equity Plan:

Let breakeven EBIT be $x

Plan II:

EPS = (EBIT - Interest) / Number of shares
EPS = ($x - $16,000) / 4,000

All Equity Plan:

EPS = (EBIT - Interest) / Number of shares
EPS = ($x - $0) / 20,000

EPS under Plan II = EPS under All Equity Plan
($x - $16,000) / 4,000 = ($x - $0) / 20,000
5 * $x - $80,000 = $x
4 * $x = $80,000
$x = $20,000

Breakeven EBIT = $20,000

Answer c.

Let breakeven EBIT be $x

Plan I:

EPS = (EBIT - Interest) / Number of shares
EPS = ($x - $8,000) / 12,000

Plan II:

EPS = (EBIT - Interest) / Number of shares
EPS = ($x - $16,000) / 4,000

EPS under Plan I = EPS under Plan II
($x - $8,000) / 12,000 = ($x - $16,000) / 4,000
$x - $8,000 = 3 * $x - $48,000
2 * $x = $40,000
$x = $20,000

Breakeven EBIT = $20,000

Answer d-1.

Answer d-2.

Plan I and All Equity Plan:

Let breakeven EBIT be $x

Plan I:

EPS = (EBIT - Interest) * (1 - tax) / Number of shares
EPS = ($x - $8,000) * (1 - 0.40) / 12,000

All Equity Plan:

EPS = (EBIT - Interest) * (1 - tax) / Number of shares
EPS = ($x - $0) * (1 - 0.40) / 20,000

EPS under Plan I = EPS under All Equity Plan
($x - $8,000) *0.60 / 12,000 = ($x - $0) * 0.60 / 20,000
5 * $x - $40,000 = 3 * $x
2 * $x = $40,000
$x = $20,000

Breakeven EBIT = $20,000

Plan II and All Equity Plan:

Let breakeven EBIT be $x

Plan II:

EPS = (EBIT - Interest) * (1 - tax) / Number of shares
EPS = ($x - $16,000) * (1 - 0.40) / 4,000

All Equity Plan:

EPS = (EBIT - Interest) * (1 - tax) / Number of shares
EPS = ($x - $0) * (1 - 0.40) / 20,000

EPS under Plan II = EPS under All Equity Plan
($x - $16,000) * 0.60 / 4,000 = ($x - $0) *0.60 / 20,000
5 * $x - $80,000 = $x
4 * $x = $80,000
$x = $20,000

Breakeven EBIT = $20,000

Answer c.

Let breakeven EBIT be $x

Plan I:

EPS = (EBIT - Interest) * (1 - tax) / Number of shares
EPS = ($x - $8,000) * (1 - 0.40) / 12,000

Plan II:

EPS = (EBIT - Interest) * (1 - tax) / Number of shares
EPS = ($x - $16,000) * (1 - 0.40) / 4,000

EPS under Plan I = EPS under Plan II
($x - $8,000) * 0.60 / 12,000 = ($x - $16,000) *0.60 / 4,000
$x - $8,000 = 3 * $x - $48,000
2 * $x = $40,000
$x = $20,000

Breakeven EBIT = $20,000