Break-even EBIT and Leverage: Company Y is comparing two different capital struc

Question

Break-even EBIT and Leverage: Company Y is comparing two different capital structures. Plan I would result in 7,000 shares of stock and $160,000 in debt. Plan II would result in 5,000 shares of stock and $340,000 in debt. The interest rate on the debt is 10 percent. A. Ignoring taxes, compare both of these plans to an ALL-EQUITY plan assuming the EBIT will be $39,000. The ALL-EQUITY plan would result in 11,000 shares of stock outstanding. Which of the three plans has the highest EPSP The lowest EPS? B. In part A, what are the breakpeven levels of EBIT for each plan as compared to that for an ALL EQUITY plan? Is one higher than the other? Why? C. IGNORING Taxes, when will EPS be identical for Plans I and ||? D. Repeat parts A, B, and C assuming that the corporate tax rate is 40 percent. Are the break-even levels of EBIT different from before? Why or why not?

Explanation / Answer

Plan I Plan II All Equity Plan Debt a 160000 340000 0 Interest rate b 10% 10% Interest amount c=a*b 16000 34000 0 EBIT d 39000 39000 39000 Less: Interest c 16000 34000 0 EBT e=d-c 23000 5000 39000 Less: Tax f 0 0 0 Net Income g=e-f 23000 5000 39000 No. of shares h 7000 5000 11000 EPS g/h 3.29 1.00 3.55 All Equity paln has highest EPS Plan II has lowest EPS

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