Question

Problem 16-4 Break-Even EBIT [LO1] Round Hammer 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 195,000 shares of stock outstanding. Under Plan II, there would be 145,000 shares of stock outstanding and $2.9 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes. a. If EBIT is $475,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b. If EBIT is $725,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) c. What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

Answer 1

Answer:

a)

under plan I:

EBIT = $475,000

net income = $475,000

EPS = $475,000 / 195,000 stocks = $2.44

under plan II:

EBIT = $475,000

net income = $475,000 - ($2,900,000 x 7%) = $272,000

EPS = $272,000 / 145,000 stocks = $1.88

b)

under plan I:

EBIT = $725,000

net income = $725,000

EPS = $725,000 / 195,000 stocks = $3.72

under plan II:

EBIT = $725,000

net income = $725,000 - ($2,900,000 x 7%) = $522,000

EPS = $522,000 / 145,000 stocks = $3.60

c)

in thousands

EBIT / 195 = (EBIT - $203) / 145

145EBIT = 195EBIT - $39,585

50EBIT = $39,585

EBIT = $39,585 / 50 = $791.7 x 1,000 = $791,700