(NEED B, D-2 and D-3) Destin Corp. is comparing two different capital structures
ID: 2719470 • Letter: #
Question
(NEED B, D-2 and D-3)
Destin Corp. is comparing two different capital structures. Plan I would result in 14,000 shares of stock and $100,000 in debt. Plan II would result in 8,000 shares of stock and $200,000 in debt. The interest rate on the debt is 6 percent.
Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $80,000. The all-equity plan would result in 20,000 shares of stock outstanding. What is the EPS for each of these plans? (Round your answers to 2 decimal places. (e.g., 32.16))
In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan?
Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II?
Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Round your answers to 2 decimal places. (e.g., 32.16))
Assuming that the corporate tax rate is 40 percent, what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan?
Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II?
(NEED B, D-2 and D-3)
Destin Corp. is comparing two different capital structures. Plan I would result in 14,000 shares of stock and $100,000 in debt. Plan II would result in 8,000 shares of stock and $200,000 in debt. The interest rate on the debt is 6 percent.
Explanation / Answer
Answer (a)
EPS
Plan I
$ 5.29
Plan II
$ 8.50
All Equity
$ 4.00
Answer (b)
EBIT
Plan I and all-equity
$ 20,000
Plan II and all-equity
$ 20,000
Answer (c)
EBIT = $ 20,000
Answer (d-1)
EPS
Plan I
$ 3.17
Plan II
$ 5.10
All Equity
$ 2.40
Answer (d-2)
EBIT
Plan I and all-equity
$ 20,000
Plan II and all-equity
$ 20,000
Answer (d-3)
EBIT = $ 20,000
working
Plan I
Number of Shares outstanding = 14000
Amount of Debt = $ 100,000
Interest rate on Debt = 6%
Plan II
Number of Shares outstanding = 8000
Amount of Debt = $ 200,000
Interest rate on Debt = 6%
All Equity firm
Number of Shares outstanding = 20000
EBIT = $ 80,000
Calculation of EPS under various Plans
All Equity Plan
Plan I
Plan II
EBIT
$ 80,000
$ 80,000
$ 80,000
Interest
0
$ 6,000
$ 12,000
EBT
$ 80,000
$ 74,000
$ 68,000
Taxes
0
0
0
Net Income
$ 80,000
$ 74,000
$ 68,000
No of shares outstanding
20000
14000
8000
Earning Per Share
$ 4.00
$5.2857
$ 8.50
Interest expense under Plan I = $ 100,000 * 6% = $ 6,000
Interest expense under Plan II = $ 200,000 * 6% = $ 12,000
Break-even EBIT of Plan I and All Equity
At break-even EBIT, EPS of Plan I should be equal to that of All Equity firm.
That is
EBIT / 20000 = ((EBIT – (0.06 * 100000))/14000
EBIT / 20000 = (EBIT - 6000)/14000
14000 * EBIT = 20000 * EBIT – 20000 * 6000
20000 * EBIT – 14000 * EBIT = 120000000
6000 * EBIT = 120000000
EBIT = 120000000 / 6000 = $ 20,000
Break-even EBIT of Plan II and All Equity
At break-even EBIT, EPS of Plan II should be equal to that of All Equity firm.
That is
EBIT/20000 = (EBIT – (0.06*200000)) / 8000
EBIT/20000 = (EBIT – 12000)/8000
8000 * EBIT = 20000 * EBIT – 20000 * 12000
EBIT * (20000 – 8000) = 20000 * 12000
EBIT * 12000 = 20000 * 12000
EBIT = (20000 * 12000)/12000 = $ 20,000
Let X be the EPS which is same for Plan I and Plan II. Then EBIT values Plan I and Plan II should be equal
EBIT = EPS * Number of Shares + INTEREST
14000 * X + 6000 = 8000 * X + 12000
14000 * X – 8000 * X = 12000 – 6000
6000 * X = 6000
X = 6000 / 6000 = $ 1.00
EBIT = 14000 * 1.00 + 6000 = 14,000 + 6,000 = $ 20,000
Corporate Tax rate = 40%
Calculation of EPS under various Plans
All Equity Plan
Plan I
Plan II
EBIT
$ 80,000
$ 80,000
$ 80,000
Interest
0
$ 6,000
$ 12,000
EBT
$ 80,000
$ 74,000
$ 68,000
Tax
$ 32,000
$ 29,600
$ 27,200
Net Income
$ 48,000
$ 44,400
$ 40,800
No of shares outstanding
20000
14000
8000
Earning Per Share
$ 2.40
$ 3.1714
$ 5.10
Break-even EBIT of Plan I and All Equity
At break-even EBIT, EPS of Plan I should be equal to that of All Equity firm.
EBIT/(0.6* 20000) = (EBIT - 6000)/(0.6 * 14000)
EBIT / 12000 = (EBIT – 6000)/8400
8400 * EBIT = 12000 * EBIT - 12000 * 6000
EBIT * (12000 – 8400) = 72000000
3600 * EBIT = 72000000
EBIT = 72000000/3600 = $ 20,000
Break-even EBIT of Plan II and All Equity
At break-even EBIT, EPS of Plan II should be equal to that of All Equity firm.
That is
EBIT/0.6* 20000 = (EBIT – 12000) / (0.6* 8000)
EBIT/12000 = (EBIT-12000)/4800
12000 * EBIT – 12000*12000 = 4800 * EBIT
EBIT * (12000 – 4800) = 144,000,000
EBIT * 7200 = 144,000,000
EBIT = 144,000,000/7200 = $ 20,000
Let X be the EPS which is same for Plan I and Plan II. Then EBIT values Plan I and Plan II should be equal
[(14000 * X)/(1-0.40)] + 6000 = [(8000 * X)/(1-0.40)] + 12000
[(14000*x)/0.6] + 6000 = [(8000 * X)/0.6] + 12000
[(14000*x)/0.6] - [(8000 * X)/0.6] = 12000 - 6000
X * [(14000/0.6) – (8000/0.6)] = 6,000
X * [6000/0.6] = 6,000
X = (6,000 * 0.6) / 6000
X = $ 0.60
Plan I EBIT = (14000 * 0.6) / (1-0.40) + 6000 = (14000 * 0.6)/0.6 + 6000 = 14000 + 6000 = 20000
Plan II EBIT = (8000 * 0.6)/(1-0.40) + 12000 = 8000 * 0.6/0.6 + 12000 = 8000+ 12000 = 20000
EPS
Plan I
$ 5.29
Plan II
$ 8.50
All Equity
$ 4.00
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.