This part of the project is to analyze the following capital structure plans. Yo

Question

This part of the project is to analyze the following capital structure plans. You will use the EBIT-EPS analysis to evaluate the two plans. One plan is all equity and one has debt and equity. Plan Plan 1: All Equity Plan 2: Some Debt Shares of Equity 80,000 50,000 Debt 0 $2,000,000 Cost of debt 0 12% Interest Expense 0 $240,000 Tax Rate 34% 34% Determine the EBIT indifference point Discuss the implications of EBIT above and below this point You must submit your backup in Excel or other supporting documentation showing how answers were reached.

Explanation / Answer

Indifference Earnings Before Interest & Taxes (Indifference EBIT) is the point of the capital structure where the corporation does not care about whether they issue new debt, have no debt and 100% equity or have a combination of both debt & equity. Here we have Equity = 50,000 Debt @12% = $2M Int on Debt = 12%*$2M = $240,000 When there is no Debt, then Equity is 80,000 Different financing decisions will have differing impacts on EPS. We can examine the effects of various financing alternatives through an EPS-EBIT analysis, which involves determining the crossover or 'indifference' EBIT at which the EPS is the same between two financing alternatives. Suppose that the firm is comparing the two possible capital structures, 1 and 2. Then, EBIT*, the indifference EBIT, is such that EPS1 = EPS2 ie (EBIT*-I1)*(1-T1)/N1 = (EBIT*-I2)*(1-T2)/N2 where EBIT* =the indifference EBIT I = the interests T= tax rate N = the number of shares outstanding No Debt With Debt Indifference EBIT (EBIT - 0)*(1-34%)/80000 (EBIT - $240000)*(1-34%)/50000 ie EBIT*50000 = (EBIT-$240000)*80000 ie 5*EBIT = 8*EBIT - 1920,000 ie EBIT = $640,000 So indifference level of EBIT is $640,000.................(Ans a) If expected EBIT >$640,000, then the plan with more debt (i.e., plan (2)) will be preferred. and If expected EBIT

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