DAR Corporation is comparing two different capital structures: an all-equity pla
ID: 2718114 • Letter: D
Question
DAR 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 170,000 shares of stock outstanding. Under Plan II, there would be 120,000 shares of stock outstanding and $2.4 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes.
If EBIT is $450,000, what is the EPS for each plan?
plan 1:
plan 2:
If EBIT is $700,000, what is the EPS for each plan?
plan 1:
plan 2:
What is the break-even EBIT?
DAR 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 170,000 shares of stock outstanding. Under Plan II, there would be 120,000 shares of stock outstanding and $2.4 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes.
If EBIT is $450,000, what is the EPS for each plan?
plan 1:
plan 2:
If EBIT is $700,000, what is the EPS for each plan?
plan 1:
plan 2:
What is the break-even EBIT?
Explanation / Answer
Answer:
Plan I
(ALL Equity)
Plan II
(Levered Plan)
a) EBIT
$450,000
EBIT
$450,000
$450,000
Less; Interest
$0
$168,000
Net Income
$450,000
$282,000
Number of Shares Outstanding
170000
120000
EPS
$2.65
$2.35
Plan A
(ALL Equity)
Plan B
(Levered Plan)
b) EBIT
$700,000
EBIT
$700,000
$700,000
Less; Interest
$0
$168,000
Net Income
$700,000
$532,000
Number of Shares Outstanding
170000
120000
EPS
$4.12
$4.43
Breakeven EBIT occurs when EPSU = EPSL – where U stands for Unlevered Firm (No debt), and L stands for Levered firm (A firm that has debt in its capital structure)
To calculate Breakeven EBIT:
EBIT/Number of shares outstanding=EBIT-(Debt*Interest rate)/Number of shares outstanding
EBIT/170000=EBIT-(2400000*7%)/120000
EBIT/170000=EBIT-168000/120000
120000EBIT=170000EBIT-2856,00,00,000
120000EBIT-170000EBIT=-2856,00,00,000
-50000 EBIT=-28560000000
EBIT=$571200
Plan I
(ALL Equity)
Plan II
(Levered Plan)
a) EBIT
$450,000
EBIT
$450,000
$450,000
Less; Interest
$0
$168,000
Net Income
$450,000
$282,000
Number of Shares Outstanding
170000
120000
EPS
$2.65
$2.35
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