Question

company Corporation is comparing two different capital structures, an allequity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 365,000 shares of stock outstanding. Under Plan II, there would be 245,000 shares interest rate on the debt of stock outstanding and $4.56 million in debt outstanding. The interest rate on the debt is 10 percent and there are no taxes. a. If EBIT is $1.25 million, which plan will result in the higher EPS? b. If EBIT is $1.75 million, which plan will result in the higher EPS? c. What is the Break even EBIT ?

Answer 1

a) If EBIT is $1.25 million, statement showing EPS

Particulars	Plan 1	Plan 2
EBIT	1250000	1250000
Less : Interest (4650000 x 10%)		465000
EBT/PAT	1250000	785000
No of shares	365000	245000
EBS (PAT/No of shares)	3.42	3.20

Plan 1 has EPS of $ 3.42 and Plan 2 has EPS of $ 3.20

Thus Plan 1 has higher EPS

b) If EBIT is $1.75 million, statement showing EPS

Particulars	Plan 1	Plan 2
EBIT	1750000	1750000
Less : Interest (4650000 x 10%)		465000
EBT/PAT	1750000	1285000
No of shares	365000	245000
EBS (PAT/No of shares)	4.79	5.24

Plan 1 has EPS of $ 4.79 and Plan 2 has EPS of $ 5.24

Thus Plan 2 has higher EPS

c) Break even EBIT can be found as follows

EBIT/No of shares = (EBIT-Interest)/No of shares

EBIT/365000 = (EBIT - 465000) / 245000

245000 EBIT = 365000(EBIT - 465000)

245000 EBIT = 365000 EBIT - 169725000000

16725000000 = 120000 EBIT

Thus EBIT = 1414375 $

Thus break even EBIT = $ 1414375