James Corporation is comparing two different capital structures: an all-equity p

Question

James 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 160,000 shares of stock outstanding. Under Plan II, there would be 80,000 shares of stock outstanding and $2.8 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

If EBIT is $350,000, Plan I's EPS is $while Plan II's EPS is $.(Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))

If EBIT is $500,000, Plan I's EPS is $and Plan II's EPS is $.(Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))

The break-even EBIT is $.(Do not include the dollar sign ($). Round your answer to the nearest whole dollar amount. (e.g., 32.))

James 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 160,000 shares of stock outstanding. Under Plan II, there would be 80,000 shares of stock outstanding and $2.8 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

Explanation / Answer

interest rate = 8%
interest on 2.8 million debt = 8% * 2.8 million = 224000

a)
tax is zero
plan 1 net profit = ebit - interest - tax
= 350000 - 0 - 0
= 350000
plan 2 net profit = ebit - interest - tax
= 350000 - 224000
= 126000

plan 1 eps = net profit/number of shares = 350000/160000 = 2.1875 = 2.19 (rounded)
plan 2 eps = net profit/number of shares = 126000/80000 = 1.575 = 1.58 (rounded)

b)
tax is zero
plan 1 net profit = ebit - interest - tax
= 500000 - 0 - 0
= 500000
plan 2 net profit = ebit - interest - tax
= 500000 - 224000
= 276000

plan 1 eps = net profit/number of shares = 500000/160000 = 3.125 = 3.13 (rounded)
plan 2 eps = net profit/number of shares = 276000/80000 = 3.45

c)
net profit = ebit - interest - tax
at break even, net profit = 0
so ebit = interest + tax
tax = 0
in plan 1 break even interest = ebit = 0
in plan 2 break even interest = ebit = 224000


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