Silverton Co. is comparing two different capital structures. Plan I would result

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.)

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.)

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            $

Explanation / Answer

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

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