Question

Trapper 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 320,000 shares of stock outstanding. Under Plan II, there would be 240,000 shares of stock outstanding and $2,272,000 in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.

Assume that EBIT is $700,000. Compute the EPS for both Plan I and Plan II.

Answer 1

Plan I EPS = $2.19

Plan II EPS = $1.97

Step-by-step explanation:

The computation of EPS for both Plan I and Plan II is shown below:-

Plan I Plan II

Expected EBIT $700,000 $700,000

Less Interest $227,200

($2,272,000 × 10%)

Profit before tax a $700,000 $472,800

Less: Tax

Earning to equity

shareholder b $700,000 $472,800

Number of equity

Shares (a ÷ b) $2.19 $1.97

Therefore for Plan I the EPS = $2.19 and for Plan II the EPS = $1.97