Rise Against Corporation is comparing two different capital structures: an all-e

Question

Rise Against 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 200,000 shares of stock outstanding. Under Plan II, there would be 150,000 shares of stock outstanding and $3.00 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes. a. If EBIT is $675,000, what is the EPS for each plan? (Round your answers to 2 decimal places.(e.g., 32.16)) EPS Plan I Plan II b. If EBIT is $925,000, what is the EPS for each plan? (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, i.e. 1,234,567.) Break-even EBIT

Explanation / Answer

Under Plan I, the unlevered company, net income is the same as EBIT with no corporate tax. The EPS under this capitalization will be

EPS = $675,000/ 200,000 shares

EPS = $3.38

Under Plan II, the levered company, EBIT will be reduced by the interest payment. The interest payment is the amount of debt times the interest rate, so:

NI = $675,000 - 0.08 * ($3,000,000)

NI = $435,000

EPS = $435,000/ 150,000 shares

EPS = $2.90

Plan 1 has higher EPS

Part B:

EPS = $925,000/ 200,000 shares

EPS = $4.63

Under Plan II, the levered company, EBIT will be reduced by the interest payment. The interest payment is the amount of debt times the interest rate, so:

NI = $925,000 - 0.08 * ($3,000,000)

NI = $685,000

EPS = $685,000/ 150,000 shares

EPS = $4.57

Plan 2 has higher EPS

Part C

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/ 200,000 = (EBIT - 0.08 * 3,000,000)/ 150,000

EBIT = 0.32 * 3,000,000

EBIT = 960,000

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