Yasmin Corporation is comparing two different capital structures, an all-equity
ID: 2645380 • Letter: Y
Question
Yasmin Corporation is comparing two different capital structures, an all-equity (Plan1) and a levered plan (Plan II). Under Plan 1 Yasmin would have 150,000 shares of stock outstanding. Under Plan II, there would be 100,000 shares of stock outstanding and $1.2 million in debt outstanding. The interest rate of the debt is 5% and there are no taxes.
a. If EBIT is $300,000, what is the EPS for each plan?
Plan 1?
Plan 2?
b. If EBIT is $550,00, what is the EPS for each plan?
Plan 1?
Plan 2?
c-1. What is the break-even EBIT?
Cost of equity?
c-2. What would the cost of equity be if the debt-equity ratio were 1?
c-3. What would the cost of equity be if the debt-equity ratio were zero?
Explanation / Answer
A) Statement of EPS (Amount in $)
Plan 1 Plan 2
EBIT 300000 300000
Less Interest (60000) (60000)
(1.2million*5%) -------------- --------------
EBT 240,000 240,000
No of share 150000 100000
EPS 1.60 2.40
(EBIT/No of share)
B) Statement of EPS if EBIT is $ 550000
Plan 1 Plan 2
EBIT 550000 550000
Less Interest (60000) (60000)
(1.2million*5%) -------------- --------------
EBT 490,000 490,000
No of share 150000 100000
EPS 3.266 4.90
(EBIT/No of share)
C-1) Break even EBIT- This is one way to dertmining the right mix of capital structure is to measure the impact of different financing plan on EPS. objective to find the level of EBIT where EPS does not change. formula to calculate break even EBIT -
Break even EBIT= (EBIT-Interest)*(1- Tax Rate)/ Equity no of share
Cost of Equity: cost of equity is the minimum rate of return where comany must generate profit in oreder to convince investor to invest in company common stock/ equity share at its current market price.
Cost of equity = Risk free rate+(Beta coefficient* market risk premium)
or Risk free rate+ Beta coefficient(Market rate of return-Risk free rate)
C-2 &3)Low value of debt equity ratio are favourable indicate less risk. higher debt to equity ratio unfavourable because it mean that business relies more on external lender thus it is higher risk.
if debt to equity ratio one mean half of assets of business financed by debts and half by shareholder. more than one mean more assets finance by debts that thoes financed by money of shareholder and vice versa
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.