Question

Wagner Industries is comparing two different capital structures. Plan I would result in 9,500 shares of stock and $361,000 in debt. Plan II would result in 12,000 shares of stock and $238,000 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 $71,000. The all-equity plan would result in 19,000 shares of stock outstanding. Which of these three plans has the highest EPS? The lowest? b. In question (1), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? Is one higher than the other? Why? c. Ignoring taxes, when will EPS be identical for Plans I and II?

Answer 1

PART A.

Computation of EPS.

Particulars	Plan I	Plan II	All equity plan
EBIT	71,000	71,000	71,000
Interest (Debt x Rate)	36,100	23,800	-
EBT (EBIT - Interest) (A)	34,900	47,200	71,000
Outstanding shares (B)	9,500	12,000	19,000
EPS (A / B)	3.67	3.93	3.74
	LOWEST	HIGHEST

PART B.

Computation of break-even EBIT between All equity plan and Plan I

Computation of break-even EBIT between All equity plan and Plan II

PART C.

Computation of break-even EBIT between Plan I and Plan II

EPS of Plan I and Plan II will be equal when EBIT is $82,840.