Question

Coldstream Corp. is comparing two different capital structures. Plan I would result in 7,500 shares of stock and $100,000 in debt. Plan II would result in 6,600 shares of stock and $120,000 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 $50,000. The all-equity plan would result in 12,000 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

a
	Plan 1	Plan 2	All Equity
EBIT	$                 50,000	$        50,000	$        50,000
Interest on Debt (100000*6% )(120000*6%)	$                   6,000	$          7,200	$                 -
Profit Before Tax	$                 44,000	$        42,800	$        50,000
No. of Shares	$                   7,500	$          6,600	$        12,000
EPS	$                     5.87	$            6.48	$            4.17

b
EPS	(EBIT-Interest)	/	No. of Shares
Plan 1
EBIT/12000	EBIT- 6000	/	$          7,500
EBIT	$                 16,000
Plan 2
EBIT/12000	EBIT- 7200	/	$          6,600
EBIT	$                 16,000
	EBIT
Plan I and all-equity	$                 16,000
Plan II and all-equity	$                 16,000

c
(EBIT-interest)/No. of Shares	=	(EBIT-interest)/No. of Shares
(EBIT-6000)/7500		(EBIT-7200/)6600
66EBIT-6000*66	=	75EBIT-7200*75
9EBIT	=	$     144,000
EBIT	=	$        16,000

d1
	Plan 1	Plan 2	All Equity
EBIT	$                 50,000	$        50,000	$        50,000
Interest on Debt (100000*6% )(120000*6%)	$                   6,000	$          7,200	$                 -
Profit Before Tax	$                 44,000	$        42,800	$        50,000
Tax	$                 17,600	$        17,120	$        20,000
Profit After	$                 26,400	$        25,680	$        30,000
No. of Shares	$                   7,500	$          6,600	$        12,000
EPS	$                     3.52	$            3.89	$            2.50

d2
EPS	(EBIT-Interest)(1-Tax rate)	/	No. of Shares
Plan 1
EBIT*(1-Tax Rate )/12000	(EBIT- 6000)*(1-Tax rate)	/	$          7,500
.60EBIT/12000	.60EBIT-*.60*6000	/	$          7,500
EBIT	$                 16,000
Plan 2
EBIT*.6/12000	(EBIT- 7200)*.6	/	$          6,600
EBIT	$                 16,000
	EBIT
Plan I and all-equity	$                 16,000
Plan II and all-equity	$                 16,000

d3
(EBIT-interest)(1-tax)/No. of Shares	=	(EBIT-interest)*(1-tax)/No. of Shares
(EBIT-6000)(1-.4)/7500		(EBIT-7200(1-.4)/)6600
66EBIT*.6-6000*66*.6	=	75EBIT*.6-7200*75*.6
5EBIT	=	$        86,400
EBIT	=	$        17,280

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