Question

Byrd 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 155,000 shares of stock outstanding. Under Plan II, there would be 105,000 shares of stock outstanding and $1.33 million in debt outstanding. The interest rate on the debt is 6 percent and there are no taxes.
a. If EBIT is $200,000, what is the EPS for each plan?

b. If EBIT is $450,000, what is the EPS for each plan?

c. What is the break-even EBIT?

Answer 1

Answer:

A. EPS for plan 1 is $1.29 and EPS for plan 2 is $1.15

B. EPS for plan 1 is $2.90 and EPS for plan 2 is $3.53

C. Break even EBIT is $247,380 and EPS = $1.60

Explanation:

EPS = Earnings per share = Earnings before tax (EBT) divided by outstanding common stock.

A.

Plan 1

EPS = 200,000 divided by 155,000 = $1.29 per share.

Plan 2

EPS = (EBIT - interest ) all divided by common stock

EPS = ($200,000 - ($1,330,000 x 6%)) / 105,000

= $1.15 per share

B.

Plan 1

EPS = 450,000 divided by 155,000 = $2.90 per share.

Plan 2

EPS = (EBIT - interest ) all divided by common stock

EPS = ($450,000 - ($1,330,000 x 6%)) / 105,000

= $3.53 per share

C.

Break even EBIT is when

EPS (plan 1) = EPS (plan 2)

If we represent the EBIT with ?

? / 155,000 = (? - ($1,330,000 x 6%)) / 105,000

? = $247,380

EPS = $1.60