Yasmin Corporation is comparing two different capital structures, an all-equity
ID: 2739818 • Letter: Y
Question
Yasmin Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Yasmin would have 190,000 shares of stock outstanding. Under Plan II, there would be 140,000 shares of stock outstanding and $2 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes. a. If EBIT is $625,000, what is the EPS for each plan? b. If EBIT is $875,000, what is the EPS for each plan? c. What is the break-even EBIT?
Explanation / Answer
Answer to part A.
Plan I
EBIT = 625,000
EPS =EBT / No. of shares = 625,000/190,000 =$ 3.29
Plan II
EBT = EBIT - Interest =625,000 - 160,000 =465000
EPS = EBT/ No.Of Shares = 465,000/ 140,000 =$ 3.32
Answer to Part B.
Plan I
EBIT = 875,000
EPS = EBIT / No.of Shares = 875,000/190,000= $ 4.61
Plan II
EBT= EBIT - Interest = 875,000-160,000 = 715,000
EPS = EBT / No. of Shares = 715,000 / 140,000= $ 5.12
Answer to Part C.
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 :
EPS for Plan I = EBIIT/ 190,000
EPS for Plan II = [EBIT - (0.08 * 2,000,000)] / 140,000
At break even EBIT, EPS for Plan I = EPS for Plan II
EBIT/190,000 = [EBIT - (0.08 * 2,000,000)] / 140,000
EBIT /190,000 = [EBIT - 160,000] /140,000
608,000 = EBIT
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