BNB Bank is comparing two different capital structures, an all-equity plan (Plan
ID: 2711426 • Letter: B
Question
BNB Bank is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the bank would have 800,000 shares of stock outstanding. Under Plan II, there would be 320,000 shares of stock outstanding and $10 million in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.
a. If EBIT is $1.5 million, which plan will result in the higher EPS?
b. If EBIT is $5 million, which plan will result in the higher EPS?
c. What is the break-even EBIT?
Explanation / Answer
a) EPS in plan 1 = EBIT/outstanding shares = 1.5/.8 = 1.875
EPS in plan 2 = (EBIT - interest rate * debt)/outstanding shares = (1.5 - 0.1*10)/.32 = 1.5625
plan 1 has greater EPS
b) EPS in plan 1 = EBIT/outstanding shares = 5/.8 = 6.25
EPS in plan 2 = (EBIT - interest rate * debt)/outstanding shares = (5 - 0.1*10)/.32 = 12.5
plan 2 has greater EPS
c) to calculate breakeven EBIT
eps in plan 1 = eps in plan 2
EBIT/.8 = (EBIT - 0.1*10)/.32
EBIT = 1.6667m
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