Cooke Co. is comparing two different capital structures. Plan I would result in
ID: 2647608 • Letter: C
Question
Cooke Co. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $315,000 in debt. Plan II would result in 12,000 shares of stock and $210,000 in debt. The interest rate on the debt is 10 percent.
Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,200. The all-equity plan would result in 18,000 shares of stock outstanding. Compute the EPS for each plan
In Requirement (1), what is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations.)
In Requirement (1), what is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations.)
Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)
What is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations.)
What is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations.)
At what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)
Cooke Co. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $315,000 in debt. Plan II would result in 12,000 shares of stock and $210,000 in debt. The interest rate on the debt is 10 percent.
Explanation / Answer
1 Calculation of EPS Plan-I Plan-II All equity EBIT $ 53,200.00 $ 53,200.00 $ 53,200.00 Less: Interest on debt $ (31,500.00) $ (21,000.00) $ - (315000*10%) (210000*10%) EBT ( EBIT - Interest ) $ 21,700.00 $ 32,200.00 $ 53,200.00 Number of Equity 9,000 12,000 18,000 EPS (EBT / Shares) $ 2.41 $ 2.68 $ 2.96 2(a) Break even EBIT level is that at which the EPS shall be same for both plan Lets assume the EBIT Be X Plan-I All equity EBIT X X Less: Interest on debt $ (31,500.00) $ - (315000*10%) EBT ( EBIT - Interest ) X-31500 X Number of Equity 9,000 18,000 EPS (EBT / Shares) (X-31500) / 9000 X /18000 Hence, (X-31500) / 9000 = X/18000 (X-31500)*18000 = X*9000 (X-31500)*2 = X 2X -63000 = X X = 63000 Hence the breakeven EBIT shall be $63000 2(b) Break even EBIT level is that at which the EPS shall be same for both plan Lets assume the EBIT Be X Plan-II All equity EBIT X X Less: Interest on debt $ (21,000.00) $ - (210000*10%) EBT ( EBIT - Interest ) X-21000 X Number of Equity 12,000 18,000 EPS (EBT / Shares) (X-21000) / 12000 X /18000 Hence, (X-21000) / 12000 = X/18000 (X-21000)*18000 = X*12000 (X-21000)*1.50 = X 1.50 X -31500 = X X = 31500 / 0.50 = 63000 Hence the breakeven EBIT shall be $63000 3 Break even EBIT level is that at which the EPS shall be same for both plan Lets assume the EBIT Be X Plan-I Plan-II EBIT X X Less: Interest on debt $ (31,500.00) $ (21,000.00) (315000*10%) (210000*10%) EBT ( EBIT - Interest ) X-31500 X-21000 Number of Equity 9,000 12,000 EPS (EBT / Shares) (X-31500) / 9000 (X-21000) / 12000 Hence, (X-31500) / 9000 = (X-21000)/12000 (X-31500)= (X-21000)/1.33 1.333*(X-31500)= (X-21000) 1.3333 X - 42000 = X -21000 X = 42000-21000 / 0.333333 = 63000 Hence the breakeven EBIT shall be $63000