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

Question

Destin Corp. is comparing two different capital structures. Plan I would result in 15,000 shares of stock and $100,000 in debt. Plan II would result in 11,500 shares of stock and $170,000 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 $70,000. The all-equity plan would result in 20,000 shares of stock outstanding. What is the EPS for each of these plans? (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?

  

  

Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II?

  

  

Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (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?

  

  

Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II?

  

Destin Corp. is comparing two different capital structures. Plan I would result in 15,000 shares of stock and $100,000 in debt. Plan II would result in 11,500 shares of stock and $170,000 in debt. The interest rate on the debt is 5 percent.

Explanation / Answer

EPS = Net Income / No. of shares

Break-even EBIT is the level of EBIT at which EPS are same.

Break-even EBIT = Interest (Plan I) x No. of shares (All-equity) / (All equity shares - Plan I shares)

= 5,000 x 20,000 / (20,000 - 15,000)

= 20,000

This is the break-even EBIT for both without tax and with tax for both plans.

Destin Plan I Plan II All Equity EBIT $ 70,000 $ 70,000 $ 70,000 Interest $   5,000 $   8,500 $         -   Net Income $ 65,000 $ 61,500 $ 70,000 EPS $     4.33 $     5.35 $     3.50 With Taxes EBIT $ 70,000 $ 70,000 $ 70,000 Interest $   5,000 $   8,500 $         -   EBT $ 65,000 $ 61,500 $ 70,000 Tax (40%) $ 26,000 $ 24,600 $ 28,000 Net Income $ 39,000 $ 36,900 $ 42,000 EPS $     2.60 $     3.21 $     2.10

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