Question

ound 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 160,000 shares of stock outstanding. Under Plan II, there would be 110,000 shares of stock outstanding and $1.4 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes. a. If EBIT is $400,000, what is the EPS for each plan

Answer 1

Answer:EPS of Plan I = $2.50

EPS of Plan II = $2.75

Explanation:

Plan I  Earning per share (EPS) = EBIT ÷ Number of shares

= $400,000 / 160,000 = $2.50

Plan II

Given that  

debt outstanding = $1.4 million and interest rate on debt is 7percent

Interest = $1,400,000 × 7% = $98,000

Plan II's EPS= (EBIT - Interest ) ÷ Number of shares

= ($400,000 - $98,000 )/  110,000

= 302,000/  110,000=2.75