DAR Corporation is comparing two different capital structures: an all-equity pla
ID: 2754109 • Letter: D
Question
DAR Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 150,000 shares of stock outstanding. Under Plan II, there would be 100,000 shares of stock outstanding and $1.2 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes.
a. If EBIT is $300,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
EPS Plan I $_____
Plan II $______
b. If EBIT is $550,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
EPS Plan I $______
Plan II $_______
c. 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.)
Break-even EBIT $_______
Explanation / Answer
Now, when there are no taxes
EBIT – Interest = Net Income
Earnings per Share = Net Income/Number of Shares Outstanding
For $1.2 mil of debt outstanding, with 5% interest rate, Interest expenses = $60,000
Q1 EBIT = $300,000
Plan 1 – All equity financing
Number of shares outstanding = 150,000
EPS = $300,000/150,000 = $2.00
Plan II – Partial debt financing
Number of shares outstanding = 100,000
EPS = ($300,000 - $60,000)/100,000 = $2.40
Q2 EBIT = $550,000
Plan 1 – All equity financing
Number of shares outstanding = 150,000
EPS = $550,000/150,000 = $3.67
Plan II – Partial debt financing
Number of shares outstanding = 100,000
EPS = ($550,000 - $60,000)/100,000 = $4.90
Q3 Break even EBIT
EBIT, such that plan 1 and plan 2 yield same EPS is the break-even point.
EBIIT/Number of Shares in plan 1 = (EBIT – Interest Expense)/Number of Shares in plan 2
EBIT/150,000 = (EBIT – 60,000)/100,000
EBIT = 1.5EBIT – (60000 * 1.5)
0.5 EBIT = 90000
EBIT = 180,000 -- > Break-even EBIT
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