Franklin Corporation is comparing two different capital structures, an all-equit
ID: 2805453 • Letter: F
Question
Franklin 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 $1.9 million in debt outstanding. The interest rate on the debt is 7 percent and there are no taxes.
If EBIT is $425,000, 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 $675,000, 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? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
Franklin 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 $1.9 million in debt outstanding. The interest rate on the debt is 7 percent and there are no taxes.
Explanation / Answer
a.
EBIT = $425,000
Under Plan 1
Number of share outstanding = 185,000
EPS under Plan 1 = $425,000 / $185,000
= $2.30
Under plan 1, EPS of company is $2.30.
Plan 2
Number of share outstanding = 135,000
Debt value = $1,900,000
Interest rate = 7%
Interest on debt = $1,900,000 × 7%
= $133,000
Interest on debt is $133,000.
EPS under plan 2 = ($425,000 - $133,000) / 135,000
= $292,000 / 135,000
= $2.16.
EPS under plan 2 is $2.16.
b.
EBIT = $675,000
Under Plan 1
Number of share outstanding = 185,000
EPS under Plan 1 = $675,000 / $185,000
= $3.65
Under plan 1, EPS of company is $3.65
Plan 2
Number of share outstanding = 135,000
Debt value = $1,900,000
Interest rate = 7%
Interest on debt = $1,900,000 × 7%
= $133,000
Interest on debt is $133,000.
EPS under plan 2 = ($675,000 - $133,000) / 135,000
= $542,000 / 135,000
= $4.01
EPS under plan 2 is $4.02.
c.
Breakeven point
EBIT / 185,000 = (EBIT – $133,000) / 135,000
($135,000 / $185,000) × EBIT = (EBIT – $133,000)
72.97% × EBIT = (EBIT – $133,000)
27.03% × EBIT = $133,000
EBIT = $492,045
Breakeven EBIT is $492,045.
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