Question

Kyle 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 715,000 shares of stock outstanding. Under Plan II, there would be 465,000 shares of stock outstanding and $6.75 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes.

a. Assume that EBIT is $1.6 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.)
EPS
Plan I $
Plan II $
b. Assume that EBIT is $3.1 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.)
EPS
Plan I $
Plan II $
c. What is the break-even EBIT? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Round your answer to the nearest whole number, e.g., 32.)
Break-even EBIT $

Answer 1

Answer and Explanation:

The computation is shown below

As we know that

1. EPS = ( Net income - dividends ) ÷ Average number of share

A.

For Plan 1

Number of share = 715,000

EPS = 1600000 ÷ 715000

= 2.23

For Plan 2

Net income = EBIT = $1.6 million = $1,600,000

Interest = 0.07*6,750,000 = 472,500

EBT = 1,127,500

Tax = 0

Net Income = 1,127,500

Numberof share = 465,000

So,

EPS = $1,127,500 ÷ 465000

= 2.42

B.

For Plan 1

EPS = 3100000 ÷ 715000

= 4.33

For Plan 2

When EBIT = 3,100,000

Interest = 0.07 × 6,750,000 = $472,500

Net Income = 2,627,500

So,

EPS = $2,627,500 ÷ 465000

= 5.65

C.

Plan 1 EBIT = Plan 2 EBIT

EBIT ÷ 715000 = (EBIT - 0.07 × $6,750,000) ÷ 465000

EBIT = 1,351,350 or $1.35 million