Cooke Co. is comparing two different capital structures. Plan I would result in

Question

Cooke Co. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $430,000 in debt. Plan II would result in 12,600 shares of stock and $275,200 in debt. The interest rate on the debt is 9 percent.

Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $54,000. The all-equity plan would result in 19,000 shares of stock outstanding. Compute the EPS for each plan. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

In Requirement (1), what is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations.)

In Requirement (1), what is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations.)

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

Compute the EPS for each plan. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

What is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations.)

What is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations.)

At what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

Cooke Co. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $430,000 in debt. Plan II would result in 12,600 shares of stock and $275,200 in debt. The interest rate on the debt is 9 percent.

Explanation / Answer

Ans;

Requirement 1:
Plan I
Net Income = EBIT - Interest - tax = 54000 - 430000 * 9% - 0 = 15300
EPS = Net Income / No. of shares = 15300 / 9000 = $1.70 per share

Plan II
Net Income = EBIT - Interest - tax = 54000 - 275200 * 9% - 0 = 29232
EPS = Net Income / No. of shares = 29232 / 12600 = $2.32 per share

All equity Plan
Net Income = EBIT - Interest - tax = 54000 - 0 - 0 = 54000
EPS = Net Income / No. of shares = 54000 / 19000 = $2.84 per share

Requirement 2:
Break-even level of EBIT is when EPS = 0
EPS = 0 implies Net income = 0
So EBIT - interest - tax = 0
EBIT - 430000 * 9% - 0 = 0
So EBIT = $29,232

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