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

Question

Destin Corp. is comparing two different capital structures. Plan I would result in 10,000 shares of stock and $ 90,000 in debt. Plan II would result in 7,600 shares of stock and $ 198,000 in debt. The interest rate on the debt is 10 percent.

a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $ 48,000. The all-equity plan would result in 12,000 shares of stock outstanding. Which of the three plans has the highest EPS? The lowest?

b. In part ( a), what are the break- even levels of EBIT for each plan as compared to that for an all- equity plan? Is one higher than the other? Why?

c. Ignoring taxes, when will EPS be identical for Plans I and II?

d. Repeat parts ( a), ( b), and ( c) assuming that the corporate tax rate is 40 percent. Are the break- even levels of EBIT different from before? Why or why not?

Explanation / Answer

The all equity plan has the highest EPS and Plan II has the lowest EPS
I II All Equity
EBIT $48,000 $48,000 $48,000
Interest 9,000 19,800
NI 39,000 28,200 48,000
EPS 39,000/10,000=3.9 28,200/76,000=3.71 48,000/12,000=4

b) In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? Is one higher than the other? Why?
EPS =(EBIT-RDD)/Shares standing
$54,000; $54,000
c) Ignoring taxes, when will EPS be identical for Plans I and II?
$54,000
d) Repeat parts (a), (b), and (c) assuming that the corporate tax rate is 40 percent. Are the break-even levels of EBIT different than before? Why or why not?
$2.34; $2.23; $2.40; $54,000; $54,000

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