Question

Silverton Co. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $342,000 in debt. Plan II would result in 12,600 shares of stock and $205,200 in debt. The interest rate on the debt is 10 percent.

a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,500. The all-equity plan would result in 18,000 shares of stock outstanding. Compute the EPS for each plan. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	EPS
Plan I	$
Plan II	$
All-equity plan	$

b. In part (a), what is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT            $

In part (a), what is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT            $

c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT            $

d. Assume the corporate tax rate is 30 percent.

Compute the EPS for each plan. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	EPS
Plan I	$
Plan II	$
All-equity plan	$

What is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT            $

What is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT            $

At what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

EBIT            $

Answer 1

a)	Plan I	Plan II	Equity
EBIT	$53,500	$53,500	$53,500
Less: Interest $342,000 x 10% ; $205,200 x 10%	$34,200	$20,520	$0
Net Income	$19,300	$32,980	$53,500
Outstanding Shares	9000	12600	18000
EPS	$2.14	$2.62	$2.97
b)
The breakeven EBIT between the all-equity capital structure and Plan I is:
EBIT/18,000 = [EBIT – 0.10($342,000)]/9000
EBIT/18,000 = (EBIT – 34,200)/9000
EBIT	$68,400
The breakeven EBIT between the all-equity capital structure and Plan II is
EBIT/18,000 = [EBIT – 0.10($205,200)]/12600
EBIT/18,000 = (EBIT – 20520)/12600
EBIT	$68,400
c)
[EBIT – 0.10($342,000)]/9000 =[ EBIT - 0.10($205,200)]/12600
EBIT	$68,400
d)
	Plan I	Plan II	Equity
EBIT	$53,500	$53,500	$53,500
Less: Interest $342,000 x 10% ; $205,200 x 10%	$34,200	$20,520	$0
EBT	$19,300	$32,980	$53,500
Tax@30%	$5,790	$9,894	$16,050
Net Income	$13,510	$23,086	$37,450
Outstanding Shares	9000	12600	18000
EPS	$1.5	$1.83	$2.08
The breakeven EBIT between the all-equity capital structure and Plan I is:
EBIT(1 –0.30)/18000 = [EBIT –0.10($342000)](1 –0.30)/9000	$68,400.00
The breakeven EBIT between the all-equity capital structure and Plan II is
EBIT(1 –0.30)/18000 = [EBIT –0.10($205200)](1 –0.30)/12600	$68,400.00
[EBIT –0.10($342 000)](1 –0.30)/9000 = [EBIT –0.10($205 200)](1 –0.30)/12600	$68,400.00