Silverton Co. is comparing two different capital structures. Plan I would result
ID: 2614565 • Letter: S
Question
Silverton Co. is comparing two different capital structures. Plan I would result in 10,000 shares of stock and $310,000 in debt. Plan II would result in 13,000 shares of stock and $217,000 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 $54,100. The all-equity plan would result in 20,000 shares of stock outstanding. Compute the EPS for each plan. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I Plan II All-equity plan b. In part (a), what is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g. 32) EBIT In part (a), what is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g, 32) EBIT c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and Il? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g, 32.) EBIT d. Assume the corporate tax rate is 34 percent. Compute the EPS for each plan. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I Plan Il All-equity plan What is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g 32.) EBIT What is the break-even level of EBIT for Plan Il as compared to that for an all-equity plan? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g, 32.) EBIT At what level of EBIT will EPS be identical for Plans I and Il? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g, 32.) EBITExplanation / Answer
a. EPS for each plan (Amounts in $)
(31000)
(310000 * 10%)
(21700)
(217000*10%)
0
b.
Financial breakeven point is the level of earnings before interest and taxes that will result in zero net income or zero earnings per share. It equals the company’s interest expense plus dividends paid to preferred stock-holders and associated taxes.
Break Even EBIT for Plan I = Preferred Dividends + Interest Expense
1 - Tax Rate
= 0 + $31000
= $31000
Break Even EBIT for All Equity Plan = Preferred Dividends + Interest Expense
1 - Tax Rate
= 0 + 0
= 0
Break Even EBIT for Plan II = Preferred Dividends + Interest Expense
1 - Tax Rate
= 0 + $21700
= $21700
Break Even EBIT for All Equity Plan = Preferred Dividends + Interest Expense
1 - Tax Rate
= 0 + 0
= 0
c. Level of EBIT where EPS is identical for Plan I & II
Let us assume the required level of EBIT to be x
Now, Plan I EPS = Plan II EPS
So, (x - interest for plan I) * (1 - tax rate) - Preferred Share Dividend / Number of shares outstanding for Plan I = (x - Interest for Plan II)* (1 - tax rate) - Preferred Share Dividend / Number of shares outstanding for Plan II
So, ( x - $31000) * ( 1- 0 ) - 0 / 10000 = ( x - $21700) * (1 - 0 ) - 0 / 13000
So, ( x - $31000) / 10000 = (x - $21700) / 13000
So, ( x - $ 31000 ) /10 = ( x - $21700) / 13
Therefore 13x - $403000 = 10x - $217000
3x = $186000
So, x = $62000
Therefore breakeven level of EBIT is $62000
d. EPS for each plan when tax rate is 34% (Amounts in $)
(31000)
(310000 * 10%)
(21700)
(217000*10%)
0
b.
Financial breakeven point is the level of earnings before interest and taxes that will result in zero net income or zero earnings per share. It equals the company’s interest expense plus dividends paid to preferred stock-holders and associated taxes.
Break Even EBIT for Plan I = Preferred Dividends + Interest Expense
1 - Tax Rate
= (0 / (1 - 0.34)) + $31000
= 0 + $31000
= $31000
Break Even EBIT for All Equity Plan = Preferred Dividends + Interest Expense
1 - Tax Rate
= (0 / ( 1 -0.34)) + 0
= 0
Break Even EBIT for Plan II = Preferred Dividends + Interest Expense
1 - Tax Rate
= (0 / (1-0.34)) + $21700
= 0+ $21700
= $ 21700
Break Even EBIT for All Equity Plan = Preferred Dividends + Interest Expense
1 - Tax Rate
= (0 / (1 - 0.34)) + 0
= 0
Let us assume the required level of EBIT to be x
Now, Plan I EPS = Plan II EPS
So, (x - interest for plan I) * (1 - tax rate) - Preferred Share Dividend / Number of shares outstanding for Plan I = (x - Interest for Plan II)* (1 - tax rate) - Preferred Share Dividend / Number of shares outstanding for Plan II
So, ( x - $31000) * ( 1- 0.34 ) - 0 / 10000 = ( x - $21700) * (1 - 0.34 ) - 0 / 13000
So, (( x - $31000) *0.66) / 10000 = ((x - $21700) * 0.66)/ 13000
So, ( x - $ 31000 ) /10 = ( x - $21700) / 13
Therefore 13x - $403000 = 10x - $217000
3x = $186000
So, x = $62000
Therefore breakeven level of EBIT is $62000
Particulars Plan I Plan II All Equity Plan EBIT 54100 54100 54100 Less: Interest(31000)
(310000 * 10%)
(21700)
(217000*10%)
0
Earnings before Tax 23100 32400 54100 Less: Tax NIL NIL NIL Earnings after tax available to shareholders (A) 23100 32400 54100 Number of shares outstanding (B) 10000 13000 20000 EPS = A/B 2.31 2.49 2.71Related Questions
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