Kyle Corporation is comparing two different capital structures, an all-equity pl
ID: 2742719 • 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 735,000 shares of stock outstanding. Under Plan II, there would be 485,000 shares of stock outstanding and $7.75 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes.
Assume that EBIT is $2.0 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32
Assume that EBIT is $3.5 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)
Requirement 1:Assume that EBIT is $2.0 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32
Explanation / Answer
Under all equity plan
Total number of share = 735,000
Plan 2, levered plan
Total number of share = 485,000
Value of debt = 7.75 million
Interest rate on debt = 7%
Annual interest payment = $7,750,000 × 7%
= $542,500.
a.
EBIT = $2 million
EPS under all equity plan is calculated below:
EPS = $2,000,000 / 735,000
= $2.72
EPS under all equity plan is $2.72 per share.
Again
EPS under second plan that is levered plan is calculated below:
EPS = (2,000,000 - $542,000) / 485,000
= $1,458,000 / 485,000
= $3.01
EPS under second plan that is levered plan is $3.01.
b.
EBIT = $3.5 million
EPS under all equity plan is calculated below:
EPS = $3,500,000 / 735,000
= $4.76
EPS under all equity plan is $2.72 per share.
Again
EPS under second plan that is levered plan is calculated below:
EPS = (3,500,000 - $542,000) / 485,000
= $2,958,000 / 485,000
= $6.46
EPS under second plan that is levered plan is $6.46.
Break Even EBIT
Break even EBIT mean the level at which Earnings per share remains unchanged.
Break Even EBIT is calculated below:
Earnings per share before issue of debt = earnings per share after issue of debt
EBIT / 735,000 = (EBIT – $542,000) / 485,000
66% × EBIT = EBIT - $542,000
34% × EBIT = $542,000
EBIT = $1,593,480
Hence, Break Even EBIT is $1,593,480
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