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 765,000 shares of stock outstanding. Under Plan II, there would be 515,000 shares of stock outstanding and $9.25 million in debt outstanding. The interest rate on the debt is 12 percent, and there are no taxes. a. Assume that EBIT is $2.6 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

Answer 1

Calculation of the
`$\text{EPS}$` for both
`$\text{plan I}$` and
`$\text{plan II}$` where EBIT is 2.6 million.

`$\text{plan I}$`
`$\text{plan II}$`

EBIT $ 2.6 million $ 2.6 million

Less : Interest $ 1.1 million

Less

PAT $ 2.6 million $ 1.5 million

Earnings available $ 2.6 million $ 1.5 million

for share holder

No. of shares 765,000 515,00

`$\text{EPS}$` = earnings available $ 3.40 $ 2.9

for share holder/no. of

shares

Hence
`$\text{EPS}$` under the
`$\text{plan I}$` is $ 3.40 and
`$\text{plan II}$` is $ 2.91

Calculating the
`$\text{EPS}$` for both plan I and
`$\text{plan II}$` where EBIT is $ 3.1 million

`$\text{plan I}$`
`$\text{plan II}$`

EBIT $ 3.1 million $ 3.1 million

Less : Interest $ 1.1 million

Less

PAT $ 3.1 million $ 2.0 million

Earnings available $3.1 million $ 2.0 million

for share holder

No. of shares 765,000 515,00

`$\text{EPS}$` = earnings available $ 4.05 $ 3.88

for share holder/no. of

shares

Hence,
`$\text{EPS}$` under the
`$\text{plan I}$` is
`$\$4.05$` and
`$\text{plan II}$` is
`$\$ 3.88$`

Calculating the breakeven EBIT

When
`$\text{accessing}$` the relative effectiveness leverage versus equity financing companies look for the level of the EBIT where
`$\text{EPS}$` remains unaffected, called the EBIT-EPS breakeven point .

To calculate the EBIT-EPS breakeven point, rearranging the
`$\text{EPS}$` formula:

`$\text{EBIT}=\text{(EPS }* \text{no. of common shares outstanding )}+\frac{\text{preferred share dividends}}{1-\text{tax rate}}+ \text {debt interest}$`

`$=(\$4.05 * 515,000)+0+\$1,100,000 = \$3,185,750$`

Therefore, the break even EBIT is $ 3,185,750