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Kolby corporation is comparing two different capital structures, Plan I, would result in 1,300 shares of...

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Kolby corporation is comparing two different capital structures,Plan I, would result in 1,300 shares of stock and $80,640 in debt.Plan II would result in 2,900 shares of stock and $19,200 in debt.The interest rate on the debt is 10%.

a. Ignoring taxes, compare both of these plans to an equity planassuming that EBIT will $10,500. The all equity plan would resultin 3,400 shares of stock outstanding. Which of the three plans hasthe highest EPS? and which one with the lowest?

b. In part (a) what are the break-even levels of EBIT for eachplan as compared to that for all equity plan? Is one higher thanthe other? Why?

c. Ignoring taxes, when will EPS be identical for Plan I andPlan II?

Answer & Explanation Solved by verified expert
4.0 Ratings (599 Votes)

a)
Plan 1
EPS = (EBIT-debt*interest rate)*(1-tax rate)/shares = (10500-80640*0.1)*(1-0)/1300=1.87 ... lowest
Plan 2
EPS = (EBIT-debt*interest rate)*(1-tax rate)/shares = (10500-19200*0.1)*(1-0)/2900=2.96
All equity plan
EPS = EBIT*(1-tax rate)/shares = 10500*(1-0)/3400=3.09 ... Highest
b)
Plan 1
Break even EBIT is the EBIT where EPS plan I = EPS all equity
EBIT*(1-tax rate)/shares = (EBIT-interest rate*debt)*(1-tax rate)/shares
EBIT*(1-0)/3400=(EBIT-80640*0.1)*(1-0)/1300
EBIT =13056
Plan 2
Break even EBIT is the EBIT where EPS plan II = EPS all equity
EBIT*(1-tax rate)/shares = (EBIT-interest rate*debt)*(1-tax rate)/shares
EBIT*(1-0)/3400=(EBIT-0.1*19200)*(1-0)/2900
EBIT =13056
c)
EBIT level when EPS I = EPS II:
(EBIT-int. rate*debt Plan I)*(1-tax rate)/shares Plan I= (EBIT-int. rate*debt Plan II)*(1-tax rate)/shares plan II
(EBIT-0.1*80640)*(1-0)/1300=(EBIT-0.1*19200)*(1-0)/2900
EBIT =13056

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Transcribed Image Text

Kolby corporation is comparing two different capital structures,Plan I, would result in 1,300 shares of stock and $80,640 in debt.Plan II would result in 2,900 shares of stock and $19,200 in debt.The interest rate on the debt is 10%.a. Ignoring taxes, compare both of these plans to an equity planassuming that EBIT will $10,500. The all equity plan would resultin 3,400 shares of stock outstanding. Which of the three plans hasthe highest EPS? and which one with the lowest?b. In part (a) what are the break-even levels of EBIT for eachplan as compared to that for all equity plan? Is one higher thanthe other? Why?c. Ignoring taxes, when will EPS be identical for Plan I andPlan II?

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