DAR Corporation is comparing two different capital structures: an all-equity pla
ID: 2711076 • Letter: D
Question
DAR 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 195,000 shares of stock outstanding. Under Plan II, there would be 145,000 shares of stock outstanding and $2.9 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes.
If EBIT is $475,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
If EBIT is $725,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
DAR 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 195,000 shares of stock outstanding. Under Plan II, there would be 145,000 shares of stock outstanding and $2.9 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes.
Explanation / Answer
EPS = (EBIT- interest)/n
Plan I = (475,000-0)/ 195,000
= 2.44
Plan II = ( 475,00 – 2,900,000 x 7%)/ 145,000
=(475,000 -203,000)/145,000
=1.88
EPS = (EBIT- interest)/n
Plan I = (725,000-0)/ 195,000
= 3.72
Plan II = (725,00 – 203,000)/ 145,000
=522,000/145,000
=3.60
EPS of unlevered firm = EPS of levered firm
(EBIT-0)/195,000 = (EBIT-203,000)/ 145,000
145 EBIT = 195 EBIT – 39585000
EBIT =39585000/( 195-145)
= 791,700
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