Question

Rise Against 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 210,000 shares of stock outstanding. Under Plan II, there would be 150,000 shares of stock outstanding and $2.28 million in debt outstanding. The interest rate on the debt is 8%, and there are no taxes.

a. If EBIT is $500,000, which plan will result in the higher EPS?

b. If EBIT is $750,000, which plan will result in the higher EPS?

c.What is the break-even EBIT(the EBIT yo make both plans indifferent from the EPS point of view)?

Answer 1

A. Plan 1 offers higher EPS of $2.38 per share

B. Plan 2 offers higher EPS of $3.73 per share

C. Break even EBIT = $666,400 and will result in an EPS of $3.17 in both plans

Step-by-step explanation:

EPS = Earnings Per Share = Earnings before tax (EBT) divided by outstanding common stock

A.

Plan 1

EBT = $500,000

Outstanding common stock = 210,000

EPS = $2.38 per share

Plan 2

EBT = EBIT minus Interest on debt = $500,000 - ($2,380,000 x 8%)

= $309,600

Outstanding common stock = 150,000

EPS = $2.06 per share

B.

Plan 1

EBT = $750,000

Outstanding common stock = 210,000

EPS = $3.57 per share

Plan 2

EBT = EBIT minus Interest on debt = $750,000 - ($2,380,000 x 8%)

= $309,600

Outstanding common stock = 150,000

EPS = $3.73 per share

C.

Break even EBIT

EPS (plan 1) = EPS (plan 2)

Let's assume EBIT = ?

? Divided by 210,000 = (? - (2,380,000 x 8%)) all divided by 150,000

? = $666,400

EPS = $3.17 in both plans