Question

Byrd Corporation 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 205,000 shares of stock outstanding. Under Plan II, there would be 155,000 shares of stock outstanding and $3.1 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes.

  

a.	If EBIT is $600,000, 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 $850,000, 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 and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)

Answer 1

a]		Plan I	Plan II
	EBIT	$        600,000	$      600,000
	Interest [3100000*8%]		$      248,000
	EBT	$        600,000	$      352,000
	Tax	$                    -	$                  -
	NI	$        600,000	$      352,000
	Number of shares	205000	155000
	EPS [NI/# shares]	$               2.93	$             2.27
b]		Plan I	Plan II
	EBIT	$        850,000	$      850,000
	Interest [3100000*8%]		$      248,000
	EBT	$        850,000	$      602,000
	Tax	$                    -	$                  -
	NI	$        850,000	$      602,000
	Number of shares	205000	155000
	EPS [NI/# shares]	$               4.15	$             3.88
c]	Breakeven EBIT is that EBIT level for which the EPS is the same under
	both the alternatives.
	EPS for Plan I = E/205000
	EPS for Plan II = (E-248000)/155000
	Equating the two EPS, we have
	E/205000 = (E-248000)/155000
	Where, E = the EBIT level for the same EPS.
	Solving for E:
	E*31 = (E-248000)*41
	248000*41 = E*10
	E = 248000*41/10 =	$     1,016,800
	VERIFICATION:
		Plan I	Plan II
	EBIT	$     1,016,800	$   1,016,800
	Interest [3100000*8%]		$      248,000
	EBT	$     1,016,800	$      768,800
	Tax	$                    -	$                  -
	NI	$     1,016,800	$      768,800
	Number of shares	205000	155000
	EPS [NI/# shares]	$               4.96	$             4.96