Question

Silverton Co. is comparing two different capital structures. Plan I would result in 8,000 shares of stock and $410,400 in debt. Plan II would result in 12,450 shares of stock and $250,200 in debt. The interest rate on the debt is 10 percent. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,300. The all-equity plan would result in 19,400 shares of stock outstanding.

Compute the EPS for each plan. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

EPS Plan I $ 1.53

Plan II $ 2.27

All-equity plan $ 2.75

b. In part (a), what is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT $ 69840

In part (a), what is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT $ 69840

c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT $ 69840

d. Assume the corporate tax rate is 34 percent. Compute the EPS for each plan. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

EPS Plan I $ 1.01

Plan II $ 1.49

All-equity plan $ 1.81

What is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT $

What is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT $

At what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) EBIT $

Answer 1

Answer d-2.

Let breakeven EBIT be $x

Plan I:

Number of shares = 8,000
Value of Debt = $410,400

Interest Expense = 10% * $410,400
Interest Expense = $41,040

EPS = [(EBIT - Interest Expense)*(1-tax)] / Number of shares
EPS = [($x - $41,040)*(1-0.34)] / 8,000
EPS = ($x - $41,040)*0.66 / 8,000

All Equity Plan:

Number of shares = 19,400

EPS = EBIT*(1-tax) / Number of shares
EPS = $x*(1-0.34)] / 19,400
EPS = $x*0.66 / 19,400

EPS Plan I = EPS All Equity Plan
($x - $41,040)*0.66 / 8,000 = $x*0.66 / 19,400
194*$x - $7,961,760 = 80*$x
114*$x = $7,961,760
$x = $69,840

Answer d-3.

Let breakeven EBIT be $x

Plan II:

Number of shares = 12,450
Value of Debt = $250,200

Interest Expense = 10% * $250,200
Interest Expense = $25,020

EPS = [(EBIT - Interest Expense)*(1-tax)] / Number of shares
EPS = [($x - $25,020)*(1-0.34)] / 12,450
EPS = ($x - $25,020)*0.66 / 12,450

All Equity Plan:

Number of shares = 19,400

EPS = EBIT*(1-tax) / Number of shares
EPS = $x*(1-0.34)] / 19,400
EPS = $x*0.66 / 19,400

EPS Plan II = EPS All Equity Plan
($x - $25,020)*0.66 / 12,450 = $x*0.66 / 19,400
1940*$x - $48,538,800 = 1,245*$x
695*$x = $48,538,800
$x = $69,840

Answer d-4.

Let breakeven EBIT be $x

Plan I:

Number of shares = 8,000
Value of Debt = $410,400

Interest Expense = 10% * $410,400
Interest Expense = $41,040

EPS = [(EBIT - Interest Expense)*(1-tax)] / Number of shares
EPS = [($x - $41,040)*(1-0.34)] / 8,000
EPS = ($x - $41,040)*0.66 / 8,000

Plan II:

Number of shares = 12,450
Value of Debt = $250,200

Interest Expense = 10% * $250,200
Interest Expense = $25,020

EPS = [(EBIT - Interest Expense)*(1-tax)] / Number of shares
EPS = [($x - $25,020)*(1-0.34)] / 12,450
EPS = ($x - $25,020)*0.66 / 12,450

EPS Plan I = EPS Plan II
($x - $41,040)*0.66 / 8,000 = ($x - $25,020)*0.66 / 12,450
1,245*$x - $51,094,800 = 800*$x - $20,016,000
445*$x = $31,078,800
$x = $69,840