Cooke Co. is comparing two different capital structures. Plan I would result in
ID: 2712957 • Letter: C
Question
Cooke Co. is comparing two different capital structures. Plan I would result in 10,500 shares of stock and $296,000 in debt. Plan II would result in 12,500 shares of stock and $222,000 in debt. The interest rate on the debt is 9 percent. Requirement 1: Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,400. The all-equity plan would result in 18,500 shares of stock outstanding. Compute the EPS for each plan. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)Explanation / Answer
Details Plan I Plan II All Equity Plan a Equity 10,500 12,500 18,500 b Debt 296,000 222,000 - c Interest Rate 9% 9% d Interest amt $ 26,640 19,980 - e EBIT $ 53,400 53,400 53,400 f Earning for Equity shareholders 26,760 33,420 53,400 Ans 1 g EPS = f/a $ 2.55 $ 2.67 $ 2.89 Ans 2 Break even EBIT PlanI against all equity plan h EPS required for Plan I 2.89 i Required Earning for Equity shareholders=h*a 30,308 j Required EBIT = i+d 56,948 a. So required Break even EBIT for plan I is $ 56,948.11 Break even EBIT PlanII against all equity plan k EPS required for Plan I 2.89 l Required Earning for Equity shareholders=l*a 36,081 m Required EBIT = l+d 56,061 b. So required Break even EBIT for plan II is $ 56,061.08 Ans 3. Assume at EBIT x , the EPS for plan I & plan II will be same so, (x-26640)/10500=(x-19980)/12500 or 12500x -333,000,000= 10500x -209,790,000 or , x=61605 So At EBIT level $61,605 , the EPS for Plan I & Plan Ii will be same Ans 4 Assumin corporate tax rate is 35% Details Plan I Plan II All Equity Plan a Equity 10,500 12,500 18,500 b Debt 296,000 222,000 - c Interest Rate 9% 9% d Interest amt $ 26,640 19,980 - e EBIT $ 53,400 53,400 53,400 f EBT 26,760 33,420 53,400 g Tax @35% 9,366 11,697 18,690 h Earning for Equity shareholders 17,394 21,723 34,710 i EPS = f/a $ 1.66 $ 1.74 $ 1.88 Break even EBIT PlanI against all equity plan j EPS required for Plan I 1.88 k Required Earning for Equity shareholders=j*a 19,700 l Required EBIT = k/0.65+d 56,948 a. So required Break even EBIT for plan I is $ 56,948.11 Break even EBIT PlanII against all equity plan m EPS required for Plan I 1.88 m Required Earning for Equity shareholders=m*a 23,453 o Required EBIT = m/0.65+d 56,061 b. So required Break even EBIT for plan II is $ 56,061.08 Assume at EBIT x , the EPS for plan I & plan II will be same so, 0.65*(x-26640)/10500=0.65(x-19980)/12500 or 8125x -216,450,000= 6825x -136,363,500 or , x=61605 So At EBIT level $61,605 , the EPS for Plan I & Plan Ii will be same