Question

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Coldstream Corp. is comparing two different capital structures. Plan I would result in 7,500 shares of...

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           $

Solutions

Expert Solution

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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