Kyle Corporation is comparing two different capital structures, an all-equity pl
ID: 2784178 • 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, the company would have 760,000 shares of stock outstanding. Under Plan II, there would be 510,000 shares of stock outstanding and $9 million in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.
a. Assume that EBIT is $2.5 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.)
b. Assume that EBIT is $3 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.)
c. What is the break-even EBIT? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Round your answer to the nearest whole number, e.g., 32.)
Break-even EBIT $
Explanation / Answer
Plan I:
Number of shares outstanding = 760,000
Plan II:
Number of shares outstanding = 510,000
Value of Debt = $9,000,000
Interest Rate = 10%
Interest Expense = 10%*$9,000,000
Interest Expense = $900,000
Answer a.
Plan I:
EPS = (EBIT - Interest) / Number of shares outstanding
EPS = ($2,500,000 - $0) / 760,000
EPS = $3.29
Plan II:
EPS = (EBIT - Interest) / Number of shares outstanding
EPS = ($2,500,000 - $900,000) / 510,000
EPS = $3.14
Answer b.
Plan I:
EPS = (EBIT - Interest) / Number of shares outstanding
EPS = ($3,000,000 - $0) / 760,000
EPS = $3.95
Plan II:
EPS = (EBIT - Interest) / Number of shares outstanding
EPS = ($3,000,000 - $900,000) / 510,000
EPS = $4.12
Answer c.
Let Break-even EBIT be $x
Plan I:
EPS = (EBIT - Interest) / Number of shares outstanding
EPS = ($x - $0) / 760,000
EPS = $x / 760,000
Plan II:
EPS = (EBIT - Interest) / Number of shares outstanding
EPS = ($x - $900,000) / 510,000
EPS under Plan I = EPS under Plan II
$x / 760,000 = ($x - $900,000) / 510,000
510,000 * $x = 760,000 * $x - $684,000,000,000
$684,000,000,000 = 250,000 * $x
$x = $2,736,000
So, Break-even EBIT is $2,736,000
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