Kolby Corp. is comparing two different capital structures. Plan I would result i

Question

Kolby Corp. is comparing two different capital structures. Plan I would result in 15,000 shares of stock and $100,000 in debt. Plan II would result in 11,500 shares of stock and $170,000 in debt. The interest rate on the debt is 5 percent.

a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $70,000. The all-equity plan would result in 20,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16)) EPS Plan I ; Plan II ; All equity

b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT Plan I and all-equity $ Plan II and all-equity

c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.) EBIT

d-1) Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16)) EPS Plan I $ Plan II $ All equity

d-2) 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? (Do not round intermediate calculations.) EBIT Plan I and all-equity $ Plan II and all-equity

d3) Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II? (Do not round intermediate calculations.) EBIT $

Explanation / Answer

a) EPS = (EBIT - Interest)/No of shares

EPS Plan 1 = (70000 - 5% *100000)/15000 = 4.33

EPS Plan 2 = (70000 - 5% *170000)/11500 = 5.34

EPS All Equity = 70000/20000 = 3.5

b) Break Even Level for EBIT with respect to Plan I and all-equity

EBIT/20000 = (EBIT - 5000)/15000

EBIT/4 = (EBIT - 5000)/3

3EBIT = 4EBIT - 20000

EBIT = $20000

Break Even Level for EBIT with respect to Plan 2 and all-equity

EBIT/20000 = (EBIT - 8500)/11500

(EBIT - 8500)/EBIT = 0.575

EBIT - 8500 = 0.575 EBIT

EBIT = $20000

c)EBIT Level at which EPS 1 will be equalt to EPS 2

(EBIT - 8500)/11500 = (EBIT - 5000)/15000

(EBIT - 8500)/(EBIT - 5000) = 11500/15000

EBIT = $20000

d1) Corporate Tax Rate = 40%

EPS = (EBIT - Interest)* (1 - Tax)/No of shares

EPS Plan 1 = (70000 - 5% *100000)* (1 - 40%)/15000 = 2.6

EPS Plan 2 = (70000 - 5% *170000)* (1 - 40%)/11500 = 3.21

EPS All Equity = 70000* (1 - 40%)/20000 = 2.1

d2) Break Even Level for EBIT with respect to Plan I and all-equity

EBIT*0.6/20000 = (EBIT - 5000)*0.6/15000

EBIT/4 = (EBIT - 5000)/3

3EBIT = 4EBIT - 20000

EBIT = $20000

Break Even Level for EBIT with respect to Plan 2 and all-equity

EBIT*0.6/20000 = (EBIT - 8500)*0.6/11500

(EBIT - 8500)/EBIT = 0.575

EBIT - 8500 = 0.575 EBIT

EBIT = $20000

d3)EBIT Level at which EPS 1 will be equalt to EPS 2

(EBIT - 8500)*(1 - Tax Rate)/11500 = (EBIT - 5000)*(1 - Tax Rate)/15000

(EBIT - 8500)*(0.6)/11500 = (EBIT - 5000)*(0.6)/15000

(EBIT - 8500)/(EBIT - 5000) = 11500/15000

EBIT = $20000

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