Kyle Corporation is comparing two different capital structures, an all-equity pl
ID: 2766768 • 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 730,000 shares of stock outstanding. Under Plan II, there would be 480,000 shares of stock outstanding and $7.50 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.
Assume that EBIT is $1.9 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
Assume that EBIT is $3.4 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).)
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).)
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 730,000 shares of stock outstanding. Under Plan II, there would be 480,000 shares of stock outstanding and $7.50 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.
Explanation / Answer
Solution:
Requirement 1 Calculation of EPS under Plan I & Plan II Assume that EBIT is $1.9 million:
Plan I:
Net income is the same as EBIT with no corporate tax.
EBIT = 1,900,000
Shares of stock outstanding = 730,000
EPS = EBIT/ Shares outstanding
= 1,900,000/ 730,000
= 2.60
Plan II:
EBIT will be reduced by the interest payment. The interest payment is the amount of debt times the interest rate, so:
EBIT = 1,900,000
Shares of stock outstanding = 480,000
Debt outstanding = 7,500,000
Net Income = 1,900,000 - 8% (7,500,000)
= 1,900,000 - 600,000
= 1,300,000
EPS = Net Income/ Shares outstanding
= 1,300,000/ 480,000
= 2.71
Plan II has the higher EPS when EBIT is 1.9 million.
Requirement 2 Calculation of EPS under Plan I & Plan II Assume that EBIT is $3.4 million:
Plan I:
Net income is the same as EBIT with no corporate tax.
EBIT = 3,400,000
Shares of stock outstanding = 730,000
EPS = EBIT/ Shares outstanding
= 3,400,000/ 730,000
= 4.66
Plan II:
EBIT will be reduced by the interest payment. The interest payment is the amount of debt times the interest rate, so:
EBIT = 3,400,000
Shares of stock outstanding = 480,000
Debt outstanding = 7,500,000
Net Income = 3,400,000 - 8% (7,500,000)
= 3,400,000 - 600,000
= 2,800,000
EPS = Net Income/ Shares outstanding
= 2,800,000/ 480,000
= 5.83
Plan II has the higher EPS when EBIT is 3.4 million.
Requirement 3 Calculation of Break-even EBIT:
To find the breakeven EBIT for two different capital structures, we simply set the equations for EPS equal to each other and solve for EBIT. The breakeven EBIT is:
EBIT/ 730,000 = [EBIT - 8% (7,500,000)]/ 480,000
480,000 EBIT = 730,000 EBIT - (600,000 * 730,000)
EBIT = (600,000 * 730,000)/ 250,000
= 1,752,000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.