A corporation is comparing two different capital structures, an all equity plan (plan A) and a levered plan (plan B). Under Plan A the corporation would have 200,000 shares of stock outstanding. Under Plan B there would be 100,000 shares of stock outstanding and $1 million in debt outstanding. The interest rate on the debt is 12% and there are no taxes. If EBIT is $200,000 calculate EPS for Plan A and Plan B _______. If EBIT is $400,000 calculate the EPS for Plan A and Plan B _______. The break-even EBIT is $_______.
| Plan A (ALL Equity) |
Plan B (Levered Plan) |
|
| a) EBIT | $200,000 | |
| EBIT | $200,000 | $200,000 |
| Less; Interest | $0 | $120,000 |
| Net Income | $200,000 | $80,000 |
| Number of Shares Outstanding | 200000 | 100000 |
| EPS | $1.00 | $0.80 |
| Plan A (ALL Equity) |
Plan B (Levered Plan) |
|
| b) EBIT | $400,000 | |
| EBIT | $400,000 | $400,000 |
| Less; Interest | $0 | $120,000 |
| Net Income | $400,000 | $280,000 |
| Number of Shares Outstanding | 200000 | 100000 |
| EPS | $2.00 | $2.80 |
Breakeven EBIT occurs when EPSU = EPSL – where U stands for Unlevered Firm (No debt), and L stands for Levered firm (A firm that has debt in its capital structure)
To calculate Breakeven EBIT:
EBIT / numner of shares Out standing=EBIT (Debt* interest rate)/ numner of shares Out standing
EBIT /200,00 =EBIT(1,000,000*0.12) /100,00
=EBIT /200,00 =EBIT(120,000) /100,00
=
100,000EBIT = 200,000(EBIT – $120,000)
100,000EBIT = 200,000EBIT – $24,000,000,000
200,000EBIT – 100,000EBIT = $24,000,000,000
100,000EBIT = $24,000,000,000
EBIT =
EBIT = $240,000
