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21 May, 06:32

Round 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 180,000 shares of stock outstanding. Under Plan II, there would be 130,000 shares of stock outstanding and $1.8 million in debt outstanding. The interest rate on the debt is 6 percent, and there are no taxes.

a. If EBIT is $225,000, what is the EPS for each plan?

b. If EBIT is $475,000, what is the EPS for each plan?

c. What is the break-even EBIT?

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  1. 21 May, 09:53
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    a. For plan I: $1.25; For plan II: $0.9

    b. For plan I: $2.64; For plan II: $2.82

    c. The break even EBIT is $388,800

    Explanation:

    a. Under Plan I: Net income = EBIT = $225,000 = > EPS = Total net income / shares outstanding = 225,000/180,000 = $1.25;

    Under Plan II: Net income = EBIT - Interest expenses = 225,000 - 1,800,000 x 6% = 117,000 = > EPS = EPS = Total net income / shares outstanding = 117,000/130,000 = $0.9;

    b. Under Plan I: Net income = EBIT = $475,000 = > EPS = Total net income / shares outstanding = 475,000/180,000 = $2.64;

    Under Plan II: Net income = EBIT - Interest expenses = 475,000 - 1,800,000 x 6% = 367,000 = > EPS = EPS = Total net income / shares outstanding = 367,000/130,000 = $2.82;

    c. Denote the break-even EBIT as x.

    At break-even EBIT, EPS will be the same for two structures.

    => x/180,000 = (x - 1,800,000 x 6%) / 130,000 13x/18 = x - 108,000 1,08,000 = 5x/18 x = 108,000 x 18/5 = $388,800.
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