Rolston Corporation is comparing two different capital structures, an all-equity
ID: 2745392 • 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
A./
PLAN I
EPS
= EBIT / NUMBER OF SHARE OUTSTANDING
= $600000 / 205000
= 2.93
PLAN II
PAT
= EBIT - INTEREST - TAX
= $600000 - ($3100000 * 8%) - 0
= $600000 - $248000
= $352000
EPS
= PAT / NUMBER OF SHARE OUTSTANDING
= $352000 / 155000
= $2.27
B./
PLAN I
EPS
= EBIT / NUMBER OF SHARE OUTSTANDING
= $850000 / 205000
= $4.15
PLAN II
PAT
= EBIT - INTEREST - TAX
= $850000 - ($3100000 * 8%) - 0
= $850000 - $248000
= $602000
EPS
= PAT / NUMBER OF SHARE OUTSTANDING
= $602000 / 155000
= $3.88
C./
BREAK EVEN EBIT
= (EPS * NUMBER OF COMMON SHARES OUTSTANDING) + DEBT INTEREST
= ($2.27 * 155000) + $248000
= $599850
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