DAR Corporation is comparing two different capital structures: an all-equity pla
ID: 2764015 • 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 195,000 shares of stock outstanding. Under Plan II, there would be 145,000 shares of stock outstanding and $2.1 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes. a. If EBIT is $550,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I $ 2.82 Plan II $ 2.63 b. If EBIT is $800,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I $ 4.1 Plan II $ 4.36 c. 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.) Break-even EBIT $
Explanation / Answer
Solution:
Since you have 2 answers already. I assume you need only answer of Break-Even EBIT. Please advise if you need EPS under different EBIT also, i will submit hte same to you.
Here is the calculation of Break-Even EBIT
Break Even EBIT (BE/EBIT) means the EBIT level at which Earings Per SHare (EPS) under two different Capital Structure mix are same.
EPS (Plan I) = EPS (Plan II)
(BE/EBIT - Interest) / No. of shares outstanding in plan i = (BE/EBIT - Interest) / No of shares outstanding in Plan II
(BE/EBIT - 0) / 195,000 = (BE/EBIT - $168,000) / 145,000
145 x BE/EBIT = 195 BE/EBIT - $32,760,000
195 BE/EBIT - 145 BE/EBIT = $32,760,000
50 BE/EBIT = $32,760,000
BE/EBIT = $32,760,000 / 50 = $655,200
Hence the Break Even EBIT where EPS under Plan I and Plan II will be same = $655,200
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