Haskell Corp. is comparing two different capital structures. Plan I would result

Question

Haskell Corp. is comparing two different capital structures. Plan I would result in 18,000 shares of stock and $95,000 in debt. Plan II would result in 14,000 shares of stock and $190,000 in debt. The interest rate on the debt is 5 percent.

Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $90,000. The all-equity plan would result in 22,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

In part (a), 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.)

Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your 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, when will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

Haskell Corp. is comparing two different capital structures. Plan I would result in 18,000 shares of stock and $95,000 in debt. Plan II would result in 14,000 shares of stock and $190,000 in debt. The interest rate on the debt is 5 percent.

Explanation / Answer

a.)                     Plan-I          Plan-II            All Equity

EBIT                 $90,000       $90,000        $90,000

Interest   $ 4,750       $ 9,500         $        0

Taxes               $         0      $        0         $        0

Net Income       $85,250       $80,500         $90,000

No. of Shares    18,000         14,000           22,000

EPS                 $4.74          $5.75             $4.09

b.) For Plan-I, Let Breakeven Level EBIT = y

Now, y/22000 = {y - (0.05 x 95,000)}/18,000

y/22000 = (y- 4750)/18000

18y = 22y - 104,500

4y = 104500

y =$26,125

Hence, Breakeven Level EBIT for Plan-I is $26,125

For Plan-II, Let Breakeven Level EBIT = y

Now, y/22000 = {y - (0.05 x 190,000)}/14,000

y/22000 = (y- 9500)/14000

14y = 22y - 209,000

8y = 209,000

y =$26,125

Hence, Breakeven Level EBIT for Plan-II is $26,125

c.) {y - (0.05 x 95,000)}/18,000 = {y - (0.05 x 190,000)}/14,000

(y-4750)/18000 = (y- 9500)/14000

14y - 104,500 = 18y - 209,000

4y = 104,500

y =$26,125

d1.)                     Plan-I          Plan-II            All Equity

EBIT                 $90,000       $90,000        $90,000

Interest   $ 4,750       $ 9,500         $        0

EBT                 $85,250       $80,500         $90,000

Taxes               $34,100      $32,200       $36,000

Net Income       $51,150       $48,300         $54,000

No. of Shares    18,000         14,000           22,000

EPS                 $2.84          $3.45             $2.45

d2.) For Plan-I, Let Breakeven Level EBIT = y

Now, yx(1-0.40)/22000 = {y - (0.05 x 95,000)}/18,000

0.60y/22000 = (y- 4750)x(1-0.40)/18000

10.80y = 13.2y - 62,700

2.40y = 62700

y =$26,125

Hence, Breakeven Level EBIT for Plan-I is $26,125

For Plan-II, Let Breakeven Level EBIT = y

Now, yx(1-0.40)/22000 = {y - (0.05 x 190,000)}x(1-0.40)/14,000

0.60y/22000 = (y- 9500)x0.60/14000

14y = 22y - 209,000

8y = 209,000

y =$26,125

Hence, Breakeven Level EBIT for Plan-II is $26,125

d3.) {y - (0.05 x 95,000)}x(1-0.40)/18,000 = {y - (0.05 x 190,000)}x(1-0.40)/14,000

(y-4750)x0.60/18000 = (y- 9500)x0.60/14000

14y - 104,500 = 18y - 209,000

4y = 104,500

y =$26,125

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