Question

Round Hammer 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 180,000 shares of stock outstanding. Under Plan II, there would be 130,000 shares of stock outstanding and $1.8 million in debt outstanding. The interest rate on the debt is 6 percent, and there are no taxes.a. If EBIT is $225,000, what is the EPS for each plan?b. If EBIT is $475,000, what is the EPS for each plan?c. What is the break-even EBIT?

Answer 1

a. $1.25 and $0.9

b. $2.64 and $2.82

c. $388,800

Step-by-step explanation:

The formula to compute the earning per share is shown below:

Earning per share = (Net income - interest) ÷ (Number of shares)

a. For Plan A

EPS = ($225,000) ÷ (180,000 shares)

= $1.25

For Plan B

EPS = ($225,000 - $108,000) ÷ (130,000 shares)

= $0.9

The interest is computed below:

= $1.8 million × 6%

= $108,000

b. For Plan A

EPS = ($475,000) ÷ (180,000 shares)

= $2.64

For Plan B

EPS = ($475,000 - $108,000) ÷ (130,000 shares)

= $2.82

The interest is computed below:

= $1.8 million × 6%

= $108,000

c. Break-even EBIT

(EBIT) ÷ (Number of shares) = (EBIT - Interest) ÷ Number of shares

(EBIT) ÷ (180,000) = (EBIT - $108,000) ÷ 130,000

After solving this,

The EBIT would be $388,800