Kyle Corporation is comparing two different capital structures, an all-equity pl
ID: 2648011 • Letter: K
Question
Kyle Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Kyle would have 790,000 shares of stock outstanding. Under Plan II, there would be 540,000 shares of stock outstanding and $10.50 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.
Assume that EBIT is $3.1 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32
Assume that EBIT is $3.6 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)
Kyle Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Kyle would have 790,000 shares of stock outstanding. Under Plan II, there would be 540,000 shares of stock outstanding and $10.50 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.
Explanation / Answer
1) Plan 1 (all Equity)
EBIT = 3,100,000
less: Interest = Nil
EBT = 3,100,000
less tax = Nil
EAT = 3,100,000
EPS = 3,100,000/ no. of ouststanding shares
= 3,100,000/ 790,000 = $3.92
Plan 2
EBIT = 3,100,000
less: Interest = (840,000) [ .08 x 10,500,000]
EBT = 2,260,000
less tax = Nil
EAT = 2,260,000
EPS = 2,260,000/ no. of ouststanding shares
= 2,260,000/ 540,000 = $4.18
2) Plan 1
Plan 1 (all Equity)
EBIT = 36,00,000
less: Interest = Nil
EBT = 3,600,000
less tax = Nil
EAT = 3,600,000
EPS = 3,600,000/ no. of ouststanding shares
= 3,600,000/ 790,000 = $4.55
Plan 2
EBIT = 3,600,000
less: Interest = 840,000
EBT = 2,760,000
less tax = Nil
EAT = 2,760,000
EPS = 2,760,000/ no. of ouststanding shares
= 2,760,000/540,000 = $5.11
3) Breakeven EBIT is the point where EPS under both the financing plan will be same.
(EBIT - interest)(1-t)/ no. of outstsnading shares =( EBIT - interest)(1-t)/ no. of outstanding shares
(EBIT - 0)(1-0)/790,000 = (EBIT - 840,000)(1-0)/540,000
Solving equation,
Breakeven EBIT = $2,666,086
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