Kyle Corporation is comparing two different capital structures, an all-equity pl
ID: 2687972 • 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 700,000 shares of stock outstanding. Under Plan II, there would be 450,000 shares of stock outstanding and $6 million in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes. a. If EBIT is $1.3 million, which plan will result in the higher EPS? b. If EBIT is $2.8 million, which plan will result in the higher EPS? c. What is the break-even EBIT?Explanation / Answer
By M& M theorem,
M&M Proposition I states that the value of a firm does NOT depend on its capital structure.
So assuming the price of stock is P. Then,
P*700,000 = P*450,000 + 6,000,000
250,000 P = 6,000,000
Solving we get
Answer 1 - P (price per share of equity) = 24
Answer 2 - P*700,000 = 16,800,000
Answer 3- Same as answer 2 - 16,800,000
As the value of the firm does not depend upon debt equity ratio according to proposition 1.
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