DAR Corporation is comparing two different capital structures: an all-equity pla
ID: 2767208 • 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 180,000 shares of stock outstanding. Under Plan II, there would be 130,000 shares of stock outstanding and $1.8 million in debt outstanding. The interest rate on the debt is 6 percent annually, and there are no taxes.
a. If EBIT is $225,000, 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 $475,000, 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
EPS when EBIT is $225,000:
Plan I = (EBIT – Tax)/Number of shares => $225,000/180,000 = $1.25
Plan II = (EBIT – Interest – Tax)/Number of shares => ($225,000 - $108,000 - $0)/130,000 = $0.9
EPS when EBIT is $475,000:
Plan I = (EBIT – Tax)/Number of shares => $475,000/180,000 = $2.64
Plan II = (EBIT – Interest – Tax)/Number of shares => ($475,000 - $108,000 - $0)/130,000 = $2.82
The breakeven EBIT between Plan I and Plan II:
EBIT/180,000 = [EBIT – 0.06($1,800,000)]/130,000
0.72222EBIT = EBIT - $108,000
EBIT = $108,000/0.27778 = $388,796.89
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