Round Hammer is comparing two different capital structures: An all-equity plan (
ID: 2815731 • Letter: R
Question
Round Hammer 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 175,000 shares of stock outstanding. Under Plan II, there would be 125,000 shares of stock outstanding and $1.7 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes.
If EBIT is $325,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
Round Hammer 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 175,000 shares of stock outstanding. Under Plan II, there would be 125,000 shares of stock outstanding and $1.7 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes.
Explanation / Answer
a)
Plan 1:
Net income = EBIT - interest
Net income = $325,000
EPS = Net income / Number of shares outstanding
EPS = 325,000 / 175,000
EPS = 1.86
Plan 2:
Net income = EBIT - interest
Net income = 325,000 - ( 0.05 * 1,700,000)
Net income = $240,000
EPS = Net income / Number of shares outstanding
EPS = 240,000 / 125,000
EPS = 1.92
b)
Plan 1:
Net income = EBIT - interest
Net income = $575,000
EPS = Net income / Number of shares outstanding
EPS = 575,000 / 175,000
EPS = 3.29
Plane 2:
Net income = EBIT - interest
Net income = 575,000 - ( 0.05 * 1,700,000)
Net income = $490,000
EPS = Net income / Number of shares outstanding
EPS = 490,000 / 125,000
EPS = 3.92
c)
EBIT / Number of shares outstanding = [ EBIT - ( 1,700,000 * 0.05)] / Number of shares outstanding
EBIT / 175,000 = [ EBIT - ( 1,700,000 * 0.05)] / 125,000
125,000EBIT = 175,000EBIT - 14,875,000,000
14,875,000,000 = 50,000EBIT
EBIT = $297,500
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