Question

DAR 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 205,000 shares of stock outstanding. Under Plan II, there would be 155,000 shares of stock outstanding and $3.1 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes. a.If EBIT is $600,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I$ 2.93 Plan II$ 2.27 b.If EBIT is $850,000, what is the EPS for each plan? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Plan I$ 4.15 Plan II$ 3.88 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.) Break-even EBIT$ **************SHOW YOUR WORK FOR BREAK-EVEN EBIT************

Answer 1

Answer:

(a) Under plan 1:

EPS = EBIT ÷ Outstanding shares

       = $600,000 ÷ 205,000

       = 2.93

Under plan 2:

EPS = EBIT ÷ Outstanding shares

       = ($600,000 - $248,000) ÷ 155,000

       = 2.27

(b) Under plan 1:

EPS = EBIT ÷ Outstanding shares

       = $850,000 ÷ 205,000

       = 2.93

Under plan 2:

EPS = EBIT ÷ Outstanding shares

       = ($850,000 - $248,000) ÷ 155,000

       = 3.88

(c) Break-even EBIT is the amount of EBIT in which EPS of plan 1 is equal to the plan 2.

Let x be the break-even EBIT,

$\frac{x}{205,000}=\frac{x-3,100,000\times0.08}{155,000}$

$\frac{155}{205}x=x-248,000$

$248,000=x[1-\frac{155}{205}]$

x = $1,016,800