James Corporation is comparing two different capital structures: an all-equity p

Question

James Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 135,000 shares of stock outstanding. Under Plan II, there would be 54,000 shares of stock outstanding and $1.35 million in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.

Required:

(a)

If EBIT is $180,000, Plan I's EPS is $ while Plan II's EPS is $. (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))

(b)

If EBIT is $630,000, Plan I's EPS is $ and Plan II's EPS is $. (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))

(c)

The break-even EBIT is $. (Do not include the dollar sign ($). Round your answer to the nearest whole dollar amount. (e.g., 32))

Explanation / Answer

a) Plan I No of share = 160,000 EBIT = $350,000 EPS = 350,000/160,000 = 2.19 Plan II No of share =80,000 EPS = 350,000/80,000 = 4.38 If EBIT is $350,000, Plan I's EPS is $2.19 while Plan II's EPS is $4.38 b)Plan I No of share = 160,000 EBIT = $500,000 EPS = $500,000/160,000 = 3.13 Plan II No of share =80,000 EPS = $500,000/80,000 = 6.25 If EBIT is $350,000, Plan I's EPS is $3.13 while Plan II's EPS is $6.25 c) Break-even EBIT (EBIT* - I1) (1 – t) (EBIT* - I2) (1- t) --------------------------- = ------------------------- n1 n2 Interest under Plan II = $2.8 million*8% =0.224million (EBIT-0)(1-0)/160,000 = (EBIT-0.224)(1-0)/80,000 EBIT/2 =EBIT-0.224 EBIT = $0.448 million The break-even EBIT is $0.448 million

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