Question

Kolby Corp. is comparing two different capital structures. Plan I would result in 32,000 shares of stock and $94,500 in debt. Plan II would result in 26,000 shares of stock and $283,500 in debt. The interest rate on the debt is 4 percent.

  

a.	Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $125,000. The all-equity plan would result in 35,000 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.)
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.)
c.	Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)
d-1.	Assuming that the corporate tax rate is 23 percent, what is the EPS for each of the plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
d-2.	Assuming that the corporate tax rate is 23 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.)
d-3.	Assuming that the corporate tax rate is 23 percent, when will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

Answer 1

Part A)

By calculating as per Income statement format,

we got the following EPS results

EPS for plan 1 is $3.79

EPS for plan 2 is $4.37

EPS for all equity plan is $3.57.

Part B)

For Plan A, Breakeven will be $3,780, as it is the interest expense, which if deducted will give null value.

For Plan B, Breakeven will be $11,340, as it is the interest expense, which if deducted will give null value.

Part C)

Considering / Assuming we need EPS of $3.57 For both plan 1 & 2,

For EPS breakeven, required EBITs will be

EBIT = $118,020 for Plan 1

EBIT = $104,160 for Plan 2.

Part D)

All the inputs here same like part a), only the tax component is added causing results to differ.

EPS for Plan 1 is $2.92

EPS for Plan 2 is $3.37

EPS for all Equity Plan is $2.75**********

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