Question

Round Hammer 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 175,000 shares of stock outstanding. Under Plan II, there would be 125,000 shares of stock outstanding and $1.7 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes.

  

a.	If EBIT is $325,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
b.	If EBIT is $575,000, what is the EPS for each plan? (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. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Answer 1

a)

Plan 1:

Net income = EBIT - interest

Net income = $325,000

EPS = Net income / Number of shares outstanding

EPS = 325,000 / 175,000

EPS = 1.86

Plan 2:

Net income = EBIT - interest

Net income = 325,000 - ( 0.05 * 1,700,000)

Net income = $240,000

EPS = Net income / Number of shares outstanding

EPS = 240,000 / 125,000

EPS = 1.92

b)

Plan 1:

Net income = EBIT - interest

Net income = $575,000

EPS = Net income / Number of shares outstanding

EPS = 575,000 / 175,000

EPS = 3.29

Plane 2:

Net income = EBIT - interest

Net income = 575,000 - ( 0.05 * 1,700,000)

Net income = $490,000

EPS = Net income / Number of shares outstanding

EPS = 490,000 / 125,000

EPS = 3.92

c)

EBIT / Number of shares outstanding = [ EBIT - ( 1,700,000 * 0.05)] / Number of shares outstanding

EBIT / 175,000 = [ EBIT - ( 1,700,000 * 0.05)] / 125,000

125,000EBIT = 175,000EBIT - 14,875,000,000

14,875,000,000 = 50,000EBIT

EBIT = $297,500