Question

Kolby Corp. is comparing two different capital structures. Plan I would result in 24,000 shares of stock and $82,500 in debt. Plan II would result in 18,000 shares of stock and $247,500 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 $85,000. The all-equity plan would result in 27,000 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 25 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 25 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 25 percent, when will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

Answer 1

a.

	All Equity Plan	Plan I	Plan II
EBIT	$ 85,000	$ 85,000	$ 85,000
Interest Expense	0	3,300	9,900
EBT	85,000	81,700	75,100
Tax Expense	0	0	0
Net Income	85,000	81,700	75,100
Common Shares Outstanding	27,000	24,000	18,000
EPS	$ 3.15	$ 3.40	$ 4.17

b. Break-even EBIT between Plan I and All Equity Plan : $ 29,700

( E - 3,300) / 24,000 = E / 27,000

or 27,000 E - 89,100,000 = 24,000 E

E = $ 29,700

Break-even EBIT between Plan II and All Equity Plan : $ 29,700

( E - 9,900 ) / 18,000 = E / 27,000

27,000 E - 267,300,000 = 18,000 E

E = $ 29,700

c. At EBIT : $ 29,700

d. -1.

	All Equity Plan	Plan I	Plan II
EBIT	$ 85,000	$ 85,000	$ 85,000
Less: Interest Expense	0	3,300	9,900
EBT	85,000	81,700	75,100
Less: Income Tax Expense ( 25 % )	21,250	20,425	18,775
Net Income	$ 63,750	$ 61,275	$ 56,325
Common Shares Outstanding	27,000	24,000	18,000
EPS	$ 2.36	$ 2.55	$ 3.13

d.-2. Break-even level of EBIT between Plan I and All Equity Plan: $ 29,700

[( E - 3,300) x 0.75] / 24,000 = 0.75 E / 27,000

27,000 ( 0.75 E - 2,475 ) = 18,000 E

20,250 E - 66,825,000 = 18,000 E

or E = $ 29,700

Break-even level of EBIT between Plan II and All Equity Plan : $ 29,700.

d-3: At EBIT = $ 29,700