Question

Rise Against Corporation is comparing two different capital structures: an all equity plan (Plan A) and a levered plan (Plan B). Under Plan A, the company would have 210,000 shares of stock outstanding. Under Plan B, there would be 150,000 shares of stock outstanding and $2.28 million in debt outstanding. The interest rate on the debt is 8%, and there are no taxes.a. If EBIT is S500,OOO, which plan will result in the higher EPS? b. If EBIT is $750,000, which plan will result in the higher EPS? c. What is the break-even EBIT?

Answer 1

Answer:

a. Plan A

b. Plan B

c. $638,400

Explanation:

The formula to compute the earning per share is shown below:

Earning per share = (Net income - interest) ÷ (Number of shares)

a. For Plan A

EPS = ($500,000) ÷ (210,000 shares) = $2.38

For Plan B

EPS = ($500,000 - $182,400) ÷ (150,000 shares) = $2.12

The interest is computed below:

= $2.28 million × 8%

= $182,400)

Plan A has higher EPS

b. For Plan A

EPS = ($750,000) ÷ (210,000 shares) = $3.57

For Plan B

EPS = ($750,000 - $182,400) ÷ (150,000 shares) = $3.78

The interest is computed below:

= $2.28 million × 8%

= $182,400)

Plan B has higher EPS

c. Break-even EBIT

(EBIT) ÷ (Number of shares) = (EBIT - Interest) ÷ Number of shares

(EBIT) ÷ (210,000) = (EBIT - $182,400) ÷$150,000

After solving this,

The EBIT would be $638,400