DAR Corporation is comparing two different capital structures: an all-equity pla

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 170,000 shares of stock outstanding. Under Plan II, there would be 120,000 shares of stock outstanding and $1.6 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

A- If EBIT is $525,000, what is the EPS for each plan?

B- If EBIT is $775,000, what is the EPS for each plan?

C- What is the break-even EBIT?

A- If EBIT is $525,000, what is the EPS for each plan?

B- If EBIT is $775,000, what is the EPS for each plan?

C- What is the break-even EBIT?

Explanation / Answer

DAR Corporation All Amounts in $ A. If EBIT is $ 525,000 Plan A EPS = $ 525,000 / 170,000 = 3.09 $ per share For Plan B EBIT will reduce by 8% of $ 1.6 million = 128000 $ Revised EBT = 397000 $ Hence, Plan B EPS = $ 397,000 / 120,000 = 3.31 $ per share B. If EBIT is $ 775,000 Plan A EPS = $ 775,000 / 170,000 = 4.56 $ per share For Plan B EBIT will reduce by 8% of $ 1.6 million = 128000 $ Revised EBT = 647000 $ Hence, Plan B EPS = $ 647,000 / 120,000 = 5.39 $ per share C. The breakeven EBIT will be a point where the EPS is the same in both the options Let us assume the EBIT as X For Case I, the EPS will be X / 170,000 For Case 2, the EPS will be (X - 128,000) / 120,000 Both these cases need to be equated Hence, X / 170,000 = (X - 128,000) / 120,000 Thus 12X = 17X - 2,176,000 Hence, X = 2,176,000 / 5 = 435200 $

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