I have this problem here but I don\'t know how to get the result since I don\'t
ID: 2735137 • Letter: I
Question
I have this problem here but I don't know how to get the result since I don't have the interest. Could you please explain how you've done it? Many thanks!
Cobalt Industries is considering two capital structures Plans. The key information is shown in the following table. Assume a 30% tax rate.
Plan B
$100,000 at 16%
coupon rate
$200,000 at 18%
coupon rate
Calculate the level of EBIT at which these two capital structure is indifferent.
A. $16,000
B. $36,000
C. $50,000
D. $52,000
E. $56,000
Sources of capital Plan APlan B
Interest-bearing debt$100,000 at 16%
coupon rate
$200,000 at 18%
coupon rate
Ordinary share equity 4,000 shares 2000 sharesExplanation / Answer
Answer is E. $56,000
Let EBIT at which these two capital structure is indifferent is 'X'
Indifference point is the level of EBIT at which EPS under two capital structure are equal..i.e.
EPS under Plan A = EPS under Plan B
((X - Interest) (1 - tax rate)) / No of shares plan A = ((X - Interest) (1- tax rate)) / No of Shares Plan B
((X - 16,000) (1 - 0.30)) / 4,000 = ((X - 36,000) (1 - 0.3)) / 2,000
(0.7X - 11,200) / 4,000 = (0.7X - 25,200) / 2,000
0.7X - 11,200 = 2(0.7X - 25,200)
0.7X - 11,200 = 1.4X - 50,400
1.4X - 0.7X = 50,400 - 11,200
0.7X = 39,200
X = 39,200 / 0.7
X = 56,000
Answer is E. $56,000