DAR Corporation is comparing two different capital structures: an all-equity pla
ID: 2761585 • Letter: D
Question
DAR Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 185,000 shares of stock outstanding. Under Plan II, there would be 135,000 shares of stock outstanding and $2.7 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes.
If EBIT is $375,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
If EBIT is $625,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
a.
If EBIT is $375,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Solution:
a.
Calculation of EPS under each plan (If EBIT $375,000)
All Equity
Levered Plan
Plan I
Plan II
Shares of Stock outstanding
185,000
135,000
Debt Value
-
$2,700,000
EBIT (given)
$375,000
$375,000
Less: Interest on Debt @ 5%
0
$135,000
EBT
$375,000
$240,000
Less: Tax
0
0
EAT
$375,000
$240,000
Divide by number of shares outstanding
185,000
135,000
EPS
$2.03
$1.78
EPS
Plan I
$2.03
Plan II
$1.78
b.
Calculation of EPS under each plan (if EBIT $625,000)
All Equity
Levered Plan
Plan I
Plan II
Shares of Stock outstanding
185,000
135,000
Debt Value
-
$2,700,000
EBIT (given)
$625,000
$625,000
Less: Interest on Debt @ 5%
0
$135,000
EBT
$625,000
$490,000
Less: Tax
0
0
EAT
$625,000
$490,000
Divide by number of shares outstanding
185,000
135,000
EPS
$3.38
$3.63
EPS
Plan I
$ 3.38
Plan II
$ 3.63
c.
Break Even EBIT
Break Even EBIT / No. of Shares outstanding in Plan I = (Break Even EBIT – Interest on Debt) / No. of Shares outstanding in plan II
Break Even EBIT /185,000 = (Break Even EBIT - $135,000) / 135,000
Break Even EBIT / 185 = (Break Even EBIT - $135,000) / 135
135 Break Even EBIT = 185 Break Even EBIT - $24,975,000
Or
185 Break Even EBIT - 135 Break Even EBIT = $24,975,000
50 Break Even EBIT = $24,975,000
Break Even EBIT = $24,975,000 / 50
Break Even EBIT = $499,500
All Equity
Levered Plan
Plan I
Plan II
Shares of Stock outstanding
185,000
135,000
Debt Value
-
$2,700,000
EBIT (given)
$375,000
$375,000
Less: Interest on Debt @ 5%
0
$135,000
EBT
$375,000
$240,000
Less: Tax
0
0
EAT
$375,000
$240,000
Divide by number of shares outstanding
185,000
135,000
EPS
$2.03
$1.78
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