Rolston Corporation is comparing two different capital structures, an all-equity
ID: 2745383 • Letter: R
Question
Rolston Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Rolston would have 205,000 shares of stock outstanding. Under Plan II, there would be 155,000 shares of stock outstanding and $3.10 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes.
If EBIT is $600,000, what is the EPS for each plan? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
If EBIT is $850,000, what is the EPS for each plan? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
What is the break-even EBIT? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations.)
Rolston Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Rolston would have 205,000 shares of stock outstanding. Under Plan II, there would be 155,000 shares of stock outstanding and $3.10 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes.
Explanation / Answer
1) Calculation Of EPS under each plans If EBIT is $600,000 :
Under plan 1 :
Since there is No interest as well as no taxes.
EPS = EBIT / Number of shares
= 600,000 / 205,000
= $2.926829
Under Plan II :
Debt Amount = $3,100,000
Interest on Debt = $248,000
EPS = (EBIT - Interest) / Number of shares
= (600,000 - 248,000) / 155,000
= $2.270967
2) Calculation Of EPS under each plans If EBIT is $850,000 :
Under plan 1 :
Since there is No interest as well as no taxes.
EPS = EBIT / Number of shares
= 850,000 / 205,000
= $4.146341
Under Plan II :
Debt Amount = $3,100,000
Interest on Debt = $248,000
EPS = (EBIT - Interest) / Number of shares
= (850,000 - 248,000) / 155,000
= $3.883871
3) Calculation of Break even EBIT :
a) Break even EBIT when EBIT was 850,000 :
Break Even EBIT = (EPS * No.of shares outstanding) / (1 - tax rate) + Debenture Interest
= (4.146341 * 155000) / 1 + $248,000
= $890682.9268
b) Break even EBIT when EBIT was 600,000 :
Break Even EBIT = (EPS * No.of shares outstanding) / (1 - tax rate) + Debenture Interest
= (2.926829 * 155000) / 1 + 248,000
= $701658.495
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