Cooke Co. is comparing two different capital structures. Plan I would result in
ID: 2742685 • Letter: C
Question
Cooke Co. is comparing two different capital structures. Plan I would result in 8,000 shares of stock and $456,000 in debt. Plan II would result in 13,700 shares of stock and $239,400 in debt. The interest rate on the debt is 11 percent.
Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $54,800. The all-equity plan would result in 20,000 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).)
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.)
Compute the EPS for each plan. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
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.)
Requirement 1:Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $54,800. The all-equity plan would result in 20,000 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
1 Calculation of EPS: Plan I Plan II All-equity plan Debt $456,000.00 $239,400.00 $ - EBIT 54800 54800 54800 Less: Interest on Debt ($50,160.00) ($26,334.00) (456000*11%) (239400*11%) EBT (A) $4,640.00 $28,466.00 $54,800.00 Number of shares (B) 8000 13700 20000 EPS = A/B = $0.58 $2.08 $2.74 2 Calculation of break-even level of EBIT for Plan I as compared to that for an all-equity plan: A break-even level of EBIT EPS for both plan should be equal EPS for Plan I = (EBIT - $50,160) / 8000 EPS for All Equity Plan = EBIT / 20000 Hence , EBIT / 20,000 = (EBIT - 50160) / 8000 EBIT / 2.5 = (EBIT - 50160) EBIT = 2.5 * EBIT - 125400 EBIT = 125400 / 1.5 EBIT = 83600 Hence Break Even EBIT = $83600 3 Calculation of break-even level of EBIT for Plan II as compared to that for an all-equity plan: A break-even level of EBIT EPS for both plan should be equal EPS for Plan II = (EBIT - 26334) / 13700 EPS for All Equity Plan = EBIT / 20000 Hence , EBIT / 20000 = (EBIT - 26334) / 13700 EBIT / 1.459854 = (EBIT - 26334) EBIT = 1.459854 * EBIT - 38443.80 EBIT = 38443.80/0.459854 EBIT = 83600 Hence Break Even EBIT = $83,600 4 Calculation of level of EBIT at which EPS will be identical for Plans I and II: EPS for Plan I = (EBIT -50160 ) / 8000 EPS for Plan II = (EBIT - 26334) / 13700 Hence, (EBIT - 26334) / 13700 = (EBIT - 50160) / 8000 (EBIT - 26334) / 1.7125 = (EBIT - 50160) EBIT - 26334 = 1.7125* EBIT - 85899 0.7125 EBIT = 59565 EBIT = 59565 / 0.7125 EBIT = 83600 Hence Break Even EBIT = $83600