2. The Lancet Co. is comparing two different capital structures. Plan I would re

Question

2. The Lancet Co. is comparing two different capital structures. Plan I would result in 800 shares of stock and $14,000 in debt. Plan II would result in 900 shares of stock and $7000 in debt. The interest rate on the debt is 11%. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $5000. The all-equity plan would result in 1000 shares outstanding.

a.Which of the three plans has the highest EPS? The lowest?

b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? Is one higher than the other? Why?

c. Ignoring taxes, when will EPS be identical for Plans I and II?

d. Repeat parts (a), (b), and (c) assuming that the corporate tax rate is 38%. Are the break-even levels of EBIT different from before? Why or why not?

Explanation / Answer

a.

Plan I Plan II All Equity Plan Debt a 14000 7000 0 Interest rate b 11% 11% Interest amount c=a*b 1540 770 0 EBIT d 5000 5000 5000 Less: Interest c 1540 770 0 EBT e=d-c 3460 4230 5000 Less: Tax f 0 0 0 Net Income g=e-f 3460 4230 5000 No. of shares h 800 900 1000 EPS g/h           4.33           4.70                      5.00 All Equity paln has highest EPS Plan I has lowest EPS

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