Break-Even EBIT and Leverage Kolby Corp. ?s comparing two different capital stru

Question

Break-Even EBIT and Leverage Kolby Corp. ?s comparing two different capital
structures. Plan I would result in 900 shares of stock and $65,700 in debt. Plan II
would result in 1,900 shares of stock and $29,200 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 a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $8,500. The all-equity plan would result ?in 2,700 shares of stock outstanding. Which of the three plans has the highest EPS? The lowest?
b. In part (a) 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?
d. Repeat parts (a), (b), and (c) assuming that the corporate tax rate is 40 percent. Are the break-even levels of EBIT different from before? Why or why not?

Explanation / Answer

a.

EPS of Plan I = (EBIT-interest)*(1-t)/number of shares

EPS of Plan I = (8500-10%*65700)/900= 2.14

EPS of Plan II= (8500-10%*29200)/1900=2.94

EPS of all equity = 8500/2700= 3.15

All equity plan has highest EPS and Plan I has lowest EPS

b. Comparing Plan 1 and all equity

(EBIT1-10%*65700)/900 = EBIT1/2700

break-even levels of EBIT1 = 9855

Comparing Plan 2 and all equity

(EBIT2-10%*29200)/1900 = EBIT2/2700

break-even levels of EBIT2 = 9855

The two breakeven level of EBIT are equal

c. (EBIT-10%*65700)/900 = (EBIT-10%*29200)/1900

EBIT = 9855

EPS will be identical for Plans I and II when EBIT= 9855

d.

EPS of Plan I = (EBIT-interest)*(1-t)/number of shares

EPS of Plan I = (8500-10%*65700)*60%/900= 1.29

EPS of Plan II= (8500-10%*29200)*60%/1900=1.76

EPS of all equity = 8500*60%/2700= 1.89

Comparing Plan 1 and all equity

(EBIT1-10%*65700)*60%/900 = EBIT1*60%/2700

break-even levels of EBIT1 = 9855

Comparing Plan 2 and all equity

(EBIT2-10%*29200)*60%/1900 = EBIT2*60%/2700

break-even levels of EBIT2 = 9855

Breakeven level of EBIT has not chnaged

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