Destin Corp. is comparing two different capital structures. Plan I would result
ID: 2752992 • Letter: D
Question
Destin Corp. is comparing two different capital structures. Plan I would result in 12,000 shares of stock and $120,000 in debt. Plan II would result in 11,500 shares of stock and $140,000 in debt. The interest rate on the debt is 6 percent.
A. 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
EBIT
Plan I and all-equity: $____
Plan II and all-equity: $____
B.
Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II?
EBIT:$__
A. 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
EBIT
Plan I and all-equity: $____
Plan II and all-equity: $____
Explanation / Answer
A. Plan I and all-equity:
(EBIT - Interest) (1 - Tax rate) / Number of equity shares = (EBIT - Interest) (1 - Tax rate) / Number of equity shares under all-equity
[X - (120000 * 6%) ] ( 1 - 0.40) / 12000 = ( X - 0) ( 1 - 0.40) / 12000 + 11500
23500 {(X - 7200) ( 1 - 0.40)} = 0.60X * 12000
23500 (0.60X - 4320) = 7200X
14100X - 101520000 = 7200X
X = 101520000 / 6900
X = 14713
Break-even level of EBIT = $14713
A. Plan II and all-equity:
(EBIT - Interest) (1 - Tax rate) / Number of equity shares = (EBIT - Interest) (1 - Tax rate) / Number of equity shares under all- equity
(Y - 140000 * 6%) (1 -0.40) / 11500 = (Y - 0) (1 - 0.40) / 11500 + 12000
0.60 ( Y - 8400) / 11500 = 0.60Y / 23500
(0.60Y - 5040)23500 = 6900Y
14100Y - 118440000 = 6900 Y
Y = 118440000 / 7200
Y = 16450
Break-even level of EBIT = $ 16450
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