Haskell Corp. is comparing two different capital structures. Plan I would result

Question

Haskell Corp. is comparing two different capital structures. Plan I would result in 18,000 shares of stock and $95,000 in debt. Plan II would result in 14,000 shares of stock and $190,000 in debt. The interest rate on the debt is 5 percent.

Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $90,000. The all-equity plan would result in 22,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.

In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.)

Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

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? (Do not round intermediate calculations.)

Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

a.

Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $90,000. The all-equity plan would result in 22,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.

EPS   Plan I $      Plan II $      All equity $    b.

In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.)

EBIT   Plan I and all-equity $      Plan II and all-equity $    c.

Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

EBIT $    d-1

Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

EPS   Plan I $      Plan II $      All equity $    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? (Do not round intermediate calculations.)

EBIT   Plan I and all-equity $      Plan II and all-equity $    d-3

Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

  EBIT $   

Explanation / Answer

a.

b.

To find the breakeven EBIT for two different capital structures, we simply set the equations for EPS equal to each other and solve for EBIT. The breakeven EBIT is:

Plan I and all-equity

EBIT/22,000 = (EBIT - 5% X $95,000)/18,000

EBIT/22,000 = (EBIT - $4,750)/18,000

Cross multiplication

EBIT X 18,000 = (EBIT - $4,750) X 22,000

18,000 EBIT = 22,000 EBIT - $104,500,000

4,000 EBIT = $104,500,000

EBIT = $104,500,000/4,000 = $26,125

Plan II and all-equity

EBIT/22,000 = (EBIT - 5% X $190,000)/14,000

BIT/22,000 = (EBIT - $9,500)/14,000

Cross multiplication

EBIT X 14,000 = (EBIT - $9,500) X 22,000

14,000 EBIT = 22,000 EBIT - $209,000,000

8,000 EBIT = $209,000,000

EBIT = $209,000,000/8,000 = $26,125

c.

at what level of EBIT will EPS be identical for Plans I and II:

(EBIT - 5% X $95,000)/18,000 = (EBIT - 5% X $190,000)/14,000

(EBIT - $4,750)/18,000 = (EBIT - $9,500)/14,000

Cross multiplication

(EBIT - $4,750) X 14,000 = (EBIT - $9,500) X 18,000

14,000 EBIT - $66,500,000 = 18,000 EBIT - $171,000,000

4,000 EBIT = $104,500,000

EBIT = $104,500,000/4,000 = $26,125

d-1.

Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm

Plan I Plan II All-equity Plan EBIT $90,000 $90,000 $90,000 Less: 5% interest on debt $4,750 $9,500 0 Net Earnings (A) $85,250 $80500 $90,000 No:of shares (B) 18,000 14,000 22,000 Earnings per share (A/B) 4.74 5.75 4.09

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