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? Company Z has a debt-equity ratio of 1.5. Its WACC is 10 percent, and its cost of debt is 7 percent. The corporate tax rate is 35%. A. What is the company's costs of equity capital? What is the company's UNLEVERED cost of equity capital? . What is the company's UNLEVERED cost of equity capital? C. What would be the cost of equity if the debt-equity ratio were 2.0? What if it were 1.02 What if it were zero?

Explanation / Answer

EPS= (EBIT-interest)/no of shares
a)
Plan I:
---------
EBIT=39000
Interest=160,000*10%=16,000
shares=7000

EPS=(39,000-16,000)/7000=3.29

Plan II:
---------
EBIT=39000
Interest=340,000*10%=34,000
shares=5000

EPS=(39,000-34,000)/5000=1

All equity
-------------

EBIT=39000
Interest=0
shares=11000

EPS=(39,000-0)/11000=3.55

Highest EPS is for All equity and lowest for Plan II

b)Break even level of Plan I and all equity

EBIT=(EPS*shares)+debt interest
=(1*7000)+(16000)= 23,000

Break even level of Plan II and all equity

EBIT=(EPS*shares)+debt interest
=(1*5000)+(34000)= 39,000.

Yes plan II is higher than Plan I

c) let EBIT be "x"
(x-16000)/7000=(x-34000)/5000
x=79,000

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