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

Question

Haskell Corp. is comparing two different capital structures. Plan I would result in 16,000 shares of stock and $100,000 in debt. Plan II would result in 13,000 shares of stock and $150,000 in debt. The interest rate on the debt is 6 percent.

Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $90,000. The all-equity plan would result in 22,000 shares of stock outstanding. What is the EPS for each of these plans?

In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan?

Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II?

Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm?

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?

Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II

Explanation / Answer

(a) EPS for each of plan I , plan II and All Equity:-   (ignore tax)

Plan I Plan II All Equity

Shares 16000 13000 22000

Debt $100000 $150000 $0

Interest rate 6% 6% -

EBIT $90000 $90000 $90000   

less: interest $6000 $9000 -

Earning after Tax $84000 $81000 $90000

EPS $5.25 $6.23 $4.09

(earning after tax/ shars)

(part a) The break-even levels of EBIT :-     (ignore tax)

     Break even level of EBIT is financial break even point ,EBIT at which Earning Per Share is 0; Therefore calculation will start from the EPS as 0 to calculate Break even for EBIT

      Plan I Plan II All Equity

  EBIT

(earning after tax + interest)   $6000 $9000 $0

less: Interest    $6000   $9000 -

     earning after tax $0 $0 $0

EPS $0 $0 $0

Note:-   EPS = earning after tax / shares outstnading

   if EPS is $0 , and, earning after tax is also $0

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