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 $500,000, what is the EPS for each plan? (Round your answers to 2 decimal places.(e.g., 32.16))
EPS
Plan I $
Plan II $
b. If EBIT is $750,000, what is the EPS for each plan? (Round your answers to 2 decimal places.(e.g., 32.16))
EPS
Plan I $
Plan II $
c. What is the break-even EBIT? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
Break-even EBIT $

Answer 1

Answer:A)Plan I  = $2.38; Plan II,= $2.12

B) Plan I = $3.57; Plan II = $3.78

C)The Break-even EBIT IS $638,400

Explanation:

earning per share is given as

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

and

a. if  EBIT is $500,000

For Plan I  when there is no interest on debt, we have that

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

For Plan II, when interest rate on debt is 8%, We have that interest becomes

$2.28 million in debt outstanding  x interest rate on debt of 8%

= $182,400

So thta the EPS on Plan II becomes

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

From the computation above we can see that Plan I has higher EPS

b.if  EBIT is $750,000

For Plan I

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

For Plan II, Using the interest as obtained from the solving above  

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

Here, Plan II has higher EPS

c. Break-even EBIT

This occurs when EPS (Plan 1) = EPS (Plan II)

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

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

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

 (EBIT)  = (EBIT - $182,400) 1.4

         (EBIT)  =  1.4 EBIT-2553360

255360=  1.4 EBIT - EBIT

2553360=  0.4 EBIT

EBIT =2553360/0.4

EBIT =$638,400

The Break-even EBIT IS $638,400