Find break-even EBIT. Destin Corp. is comparing two different capital structures

Question

Find break-even EBIT.

Destin Corp. is comparing two different capital structures. Plan I would result in 12,000 shares of stock and $120,000 in debt. Plan Il would result in 11,500 shares of stock and $140,000 in debt. The interest rate on the debt is 6 percent a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $70,000 The all-equity plan would result in 15,000 shares of stock outstanding. What is the EPS for each of these plans? (Round your answers to 2 decimal places. (e.g., 32.16) EPS an Plan II All equity 5.23 5.36 4.67 b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity an EBIT Plan I and all-equity Plan II and all-equity 36000 36000 c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and l? EBIT 36000 d-1 Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Round your answers to 2 decimal places. (e.g., 32.16)) EPS an Plan II All equity 3.14 3.21 2.80 d-2 Assuming that the corporate tax rate is 40 percent, what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? EBIT Plan I and all-equity Plan Il and all-equity $ d-3 Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and l? EBIT

Explanation / Answer

Answer d-2.

Pan I and all-equity:

Let breakeven EBIT be $x

All-equity Plan:

Number of shares = 15,000

EPS = [EBIT - Interest Expense]*(1 - tax) / Number of shares
EPS = [$x - $0]*(1 - 0.40) / 15,000
EPS = $x * 0.60 / 15,000

Plan I:

Number of shares = 12,000
Value of Debt = $120,000

Interest Expense = 6% * $120,000
Interest Expense = $7,200

EPS = [EBIT - Interest Expense]*(1 - tax) / Number of shares
EPS = [$x - $7,200]*(1 - 0.40) / 12,000
EPS = [$x - $7,200] * 0.60 / 12,000

EPS under Plan I = EPS under all-equity Plan
[$x - $7,200] * 0.60 / 12,000 = $x * 0.60 / 15,000
5*$x - $36,000 = 4*$x
$x = $36,000

So, breakeven EBIT is $36,000

Pan II and all-equity:

Let breakeven EBIT be $x

All-equity Plan:

Number of shares = 15,000

EPS = [EBIT - Interest Expense]*(1 - tax) / Number of shares
EPS = [$x - $0]*(1 - 0.40) / 15,000
EPS = $x * 0.60 / 15,000

Plan II:

Number of shares = 11,500
Value of Debt = $140,000

Interest Expense = 6% * $140,000
Interest Expense = $8,400

EPS = [EBIT - Interest Expense]*(1 - tax) / Number of shares
EPS = [$x - $8,400]*(1 - 0.40) / 11,500
EPS = [$x - $8,400] * 0.60 / 11,500

EPS under Plan II = EPS under all-equity Plan
[$x - $8,400] * 0.60 / 11,500 = $x * 0.60 / 15,000
30*$x - $252,000 = 23*$x
7*$x = $252,000
$x = $36,000

So, breakeven EBIT is $36,000

Answer d-3.

Let breakeven EBIT be $x

Plan I:

Number of shares = 12,000
Value of Debt = $120,000

Interest Expense = 6% * $120,000
Interest Expense = $7,200

EPS = [EBIT - Interest Expense]*(1 - tax) / Number of shares
EPS = [$x - $7,200]*(1 - 0.40) / 12,000
EPS = [$x - $7,200] * 0.60 / 12,000

Plan II:

Number of shares = 11,500
Value of Debt = $140,000

Interest Expense = 6% * $140,000
Interest Expense = $8,400

EPS = [EBIT - Interest Expense]*(1 - tax) / Number of shares
EPS = [$x - $8,400]*(1 - 0.40) / 11,500
EPS = [$x - $8,400] * 0.60 / 11,500

EPS under Plan II = EPS under Plan II
[$x - $8,400] * 0.60 / 11,500 = [$x - $7,200] * 0.60 / 12,000
24*$x - $201,600 = 23*$x - $165,600
$x = $36,000

So, breakeven EBIT is $36,000

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