Sanborn Corp. is comparing two different capital structures. Plan I would result
ID: 2757105 • Letter: S
Question
Sanborn Corp. is comparing two different capital structures. Plan I would result in 8,000 shares of stock and $80,000 in debt. Plan II would result in 6,000 shares of stock and $120,000 in debt. The interest rate on the debt is 6 percent.
Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $50,000. The all-equity plan would result in 12,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)
Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)
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? (Do not round intermediate calculations.)
Assuming that the corporate tax rate is 40 percent, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)
Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $50,000. The all-equity plan would result in 12,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)
d-1Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)
d-2
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? (Do not round intermediate calculations.)
EBIT Plan I and all-equity $ Plan II and all-equity $
d-3
Assuming that the corporate tax rate is 40 percent, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)
Explanation / Answer
Plan I
Plan II
All Equity
Particulars
8000 Shares and $80,000 Debt
6000 Shares and $120,000 Debt
12000 Shares
EBIT
$ 50,000.00
$ 50,000.00
$ 50,000.00
Less : Interest @6%
$ 4,800.00
$ 7,200.00
$ -
PBT
$ 45,200.00
$ 42,800.00
$ 50,000.00
Less : Tax @ 40%
$ 18,080.00
$ 17,120.00
$ 20,000.00
PAT
$ 27,120.00
$ 25,680.00
$ 30,000.00
No of shares outstanding
8000
6000
12000
EPS=PAT/No of Shares outstanding
$3.39
$4.28
$2.50
EPS
Plan I
$ 3.39
Plan II
$ 4.28
All Equity
$ 2.50
Computation of EBIT Plan I
(EBIT-Interest 1)(1-t)/n1=(EBIT-Interest 2)(1-t)/n2
T=tax rate
Interest 1 = $50,000 debt x 6%=$4,800
Interest 2= Nil under all Equity Plan
N1= No of shares outstanding under Plan I
N2= No of shares outstanding under All Equity
(EBIT-$4,800)(1-0.40)/8,000=(EBIT)(1-0.40)/12,000
(EBIT-$4,800)(0.60)/8,000=(EBIT)(0.60)/12,000
(0.6EBIT-$2,880)/8,000=(0.6EBIT)/12,000
(0.6EBIT-$2,880)/8=(0.6EBIT)/12
(0.6EBIT-$2,880)/2=(0.6EBIT)/3
(0.6EBIT-$2,880) x 3=(0.6EBIT)x 2
(1.8 EBIT-$8,640)=(1.2 EBIT)
0.6 EBIT=$8640
EBIT=$8640/0.6
EBIT=$14,400
Plan I
All Equity
Particulars
8000 Shares and $80,000 Debt
12000 Shares
EBIT
$ 14,400.00
$ 14,400.00
Less : Interest @6%
$ 4,800.00
$ -
PBT
$ 9,600.00
$ 14,400.00
Less : Tax @ 40%
$ 3,840.00
$ 5,760.00
PAT
$ 5,760.00
$ 8,640.00
No of shares outstanding
8000
12000
EPS=PAT/No of Shares outstanding
$0.72
$0.72
Breakeven EBIT =$14,400
Now let us compute Break Even EBIT for Plan II:
(EBIT-Interest 1)(1-t)/n1=(EBIT-Interest 2)(1-t)/n2
T=tax rate
Interest 1 = $80,000 debt x 6%=$7,200
Interest 2= Nil under all Equity Plan
N1= No of shares outstanding under Plan II
N2= No of shares outstanding under All Equity
(EBIT-$7,200)(1-0.40)/6,000=(EBIT)(1-0.40)/12,000
(EBIT-$7,200)(0.60)/6,000=(EBIT)(0.60)/12,000
(0.6EBIT-$4,320)/6,000=(0.6EBIT)/12,000
(0.6EBIT-$4,320)/6=(0.6EBIT)/12
(0.6EBIT-$4,320)=(0.6EBIT)/2
(0.6EBIT-$4,320)=(0.3EBIT)
0.3EBIT=$4,320
EBIT=$4,320/0.3
EBIT=$14,400
Breakeven EBIT =$14,400
Refer Below
Plan II
All Equity
Particulars
6000 Shares and $120,000 Debt
12000 Shares
EBIT
$ 14,400.00
$ 14,400.00
Less : Interest @6%
$ 7,200.00
$ -
PBT
$ 7,200.00
$ 14,400.00
Less : Tax @ 40%
$ 2,880.00
$ 5,760.00
PAT
$ 4,320.00
$ 8,640.00
No of shares outstanding
6000
12000
EPS=PAT/No of Shares outstanding
$0.72
$0.72
-----------------------------------------------------------------------------------------------------------------------------
(EBIT-Interest 1)(1-t)/n1=(EBIT-Interest 2)(1-t)/n2
T=tax rate
Interest 1 = $50,000 debt x 6%=$4,800
Interest 2 = $80,000 debt x 6%=$7,200
N1= No of shares outstanding under Plan I
N2= No of shares outstanding under Plan II
(EBIT-$4,800)(1-0.40)/8,000=(EBIT-$7,200)(1-0.40)/6,000
(EBIT-$4,800)(0.60)/8,000=(EBIT-$7,200)(0.60)/6,000
($EBIT-$4,800)(0.60)/8,000=(EBIT-$7,200)(0.60)/6,000
(0.6 EBIT-$2,880)/8,000=(0.6 EBIT-$4,320)/6,000
(0.6 EBIT-$2,880)/8,000=(0.6 EBIT-$4,320)/6,000
(0.6 EBIT-$2,880)/8 =(0.6 EBIT-$4,320)/6
(0.6 EBIT-$2,880)/4 =(0.6 EBIT-$4,320)/3
(0.6 EBIT-$2,880) x 3 =(0.6 EBIT-$4,320) x 4
(1.8 EBIT-$8,640) =(2.4 EBIT-$17,280)
2.4 EBIT-1.8 EBIT =$17,280-$8,640
0.6 EBIT=$8,640
EBIT=$8,640/0.6=14,400
Refer the below table.
Plan I
Plan II
Particulars
8000 Shares and $80,000 Debt
6000 Shares and $120,000 Debt
EBIT
$ 14,400.00
$ 14,400.00
Less : Interest @6%
$ 4,800.00
$ 7,200.00
PBT
$ 9,600.00
$ 7,200.00
Less : Tax @ 40%
$ 3,840.00
$ 2,880.00
PAT
$ 5,760.00
$ 4,320.00
No of shares outstanding
8000
6000
EPS=PAT/No of Shares outstanding
$0.72
$0.72
Breakeven EBIT =$14,400
Plan I
Plan II
All Equity
Particulars
8000 Shares and $80,000 Debt
6000 Shares and $120,000 Debt
12000 Shares
EBIT
$ 50,000.00
$ 50,000.00
$ 50,000.00
Less : Interest @6%
$ 4,800.00
$ 7,200.00
$ -
PBT
$ 45,200.00
$ 42,800.00
$ 50,000.00
Less : Tax @ 40%
$ 18,080.00
$ 17,120.00
$ 20,000.00
PAT
$ 27,120.00
$ 25,680.00
$ 30,000.00
No of shares outstanding
8000
6000
12000
EPS=PAT/No of Shares outstanding
$3.39
$4.28
$2.50
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