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 185,000 shares of stock outstanding. Under Plan II, there would be 135,000 shares of stock outstanding and $2.7 million in debt outstanding. The interest rate on the debt is 5 percent, and there are no taxes.
If EBIT is $375,000, what is the EPS for each plan?

Answer 1

Answer:

EPS

Plan I     $2.03 per share

Plan II    $1.78 per share

Explanation:

Plan I

As this plan is all equity plan, so there is no debt and no interest expense as well.

In the absence of taxes, We will use the EBIT  in the calculation of EPS

EPS  = Net Earning / Outstanding numbers of shares = $375,000 / 185,000 = $2.03 per share

Plan II

In this levered plan we have debt and equity combination. We also have to deduct the interest expense from EBIT to calculate the net income.

Interest Expense = $2,700,000 x 5% = $135,000

Net Income  = EBIT - Interest Expense = $375,000 - $135,000 = $240,000

EPS = Net Income / Outstanding numbers of shares = $240,000 / 135,000 = $1.8 per share