Kyle Corporation is comparing two different capital structures, an all-equity pl
ID: 2758233 • 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 710,000 shares of stock outstanding. Under Plan II, there would be 460,000 shares of stock outstanding and $6.50 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes. Requirement 1: Assume that EBIT is $1.5 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 Requirement 2: Assume that EBIT is $3.0 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., 32.16).) Requirement 3: What is the break-even EBIT? (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars(e.g.,1,234,567).)Explanation / Answer
Requirement 1 :
EBIT = $ 1.5 million= 1500000 $
Plan 1 : Outstanding SHares = 710,000 , Interest= 0 , Tax=0
Profit after tax (PAT) = EBIT- Interest-Tax = 1500000 -0-0= 1500000 $
EPS = PAT/Outstanding Shares = 2.113 $ per share
Plan 2 : Outstanding SHares = 460,000 , Interest= 6.5million* 8% = 520,000 , Tax=0
Profit after tax (PAT) = EBIT- Interest-Tax = 1500000 -520000-0= 980,000 $
EPS = PAT/Outstanding Shares = 980000/460000=2.13 $ per share
Requirement 2:
EBIT = $ 3 million= 3000000 $
Plan 1 : Outstanding Shares = 710,000 , Interest= 0 , Tax=0
Profit after tax (PAT) = EBIT- Interest-Tax = 3000000 -0-0= 3000000 $
EPS = PAT/Outstanding Shares = 4.22 $ per share
Plan 2 : Outstanding Shares = 460,000 , Interest= 6.5million*8% = 520,000 , Tax=0
Profit after tax (PAT) = EBIT- Interest-Tax = 3000000 -520000-0= 2480000 $
EPS = PAT/Outstanding Shares = 2480000/460000=5.39 $ per share
Requirement 3 :
Break even EBIT is that level of EBIT where EPS of both the capital structures are same.
=> EBIT/710000 = (EBIT-520000)/460000
Solving above, we get :-
=> Break even EBIT = 1476800 $
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