Question

Silverton Co. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $430,000 in debt. Plan II would result in 12,600 shares of stock and $275,200 in debt. The interest rate on the debt is 9 percent.

a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $54,000. The all-equity plan would result in 19,000 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 32 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

Answer a.

All-equity Plan:

Number of shares outstanding = 19,000

Plan I:

Number of shares outstanding = 9,000
Value of Debt = $430,000

Interest Expense = 9% * $430,000
Interest Expense = $38,700

Plan II:

Number of shares outstanding = 12,600
Value of Debt = $275,200

Interest Expense = 9% * $275,200
Interest Expense = $24,768

Answer b.

Let Breakeven EBIT be $x

All-equity Plan:

EPS = (EBIT - Interest Expense) / Number of shares outstanding
EPS = ($x - $0) / 19,000

Plan I:

EPS = (EBIT - Interest Expense) / Number of shares outstanding
EPS = ($x - $38,700) / 9,000

Plan II:

EPS = (EBIT - Interest Expense) / Number of shares outstanding
EPS = ($x - $24,768) / 12,600

Plan I and All-equity Plan:

EPS under Plan I and EPS under All-equity Plan
($x - $38,700) / 9,000 = ($x - $0) / 19,000
19 * $x - $735,300 = 9 * $x
10 * $x = $735,300
$x = $73,530

Breakeven EBIT is $73,530

Plan II and All-equity Plan:

EPS under Plan II and EPS under All-equity Plan
($x - $24,768) / 12,600 = ($x - $0) / 19,000
95 * $x - $2,352,960 = 63 * $x
32 * $x = $2,352,960
$x = $73,530

Breakeven EBIT is $73,530

Answer c.

Plan I and Plan II:

EPS under Plan I and EPS under Plan II
($x - $38,700) / 9,000 = ($x - $24,768) / 12,600
14 * $x - $541,800 = 10 * $x - $247,680
4 * $x = $294,120
$x = $73,530

Breakeven EBIT is $73,530

Answer d-1.

Answer d-2.

Let Breakeven EBIT be $x

All-equity Plan:

EPS = (EBIT - Interest Expense) * (1 - tax) / Number of shares outstanding
EPS = ($x - $0) * (1 - 0.32) / 19,000

Plan I:

EPS = (EBIT - Interest Expense) * (1 - tax) / Number of shares outstanding
EPS = ($x - $38,700) * (1 - 0.32) / 9,000

Plan II:

EPS = (EBIT - Interest Expense) * (1 - tax) / Number of shares outstanding
EPS = ($x - $24,768) * (1 - 0.32) / 12,600

Plan I and All-equity Plan:

EPS under Plan I and EPS under All-equity Plan
($x - $38,700) * 0.68 / 9,000 = ($x - $0) * 0.68 / 19,000
19 * $x - $735,300 = 9 * $x
10 * $x = $735,300
$x = $73,530

Breakeven EBIT is $73,530

Plan II and All-equity Plan:

EPS under Plan II and EPS under All-equity Plan
($x - $24,768) * 0.68 / 12,600 = ($x - $0) * 0.68 / 19,000
95 * $x - $2,352,960 = 63 * $x
32 * $x = $2,352,960
$x = $73,530

Breakeven EBIT is $73,530

Answer d-3.

Plan I and Plan II:

EPS under Plan I and EPS under Plan II
($x - $38,700) * 0.68 / 9,000 = ($x - $24,768) * 0.68 / 12,600
14 * $x - $541,800 = 10 * $x - $247,680
4 * $x = $294,120
$x = $73,530

Breakeven EBIT is $73,530