Cooke Co. is comparing two different capital structures. Plan I would result in
ID: 2758313 • Letter: C
Question
Cooke Co. is comparing two different capital structures. Plan I would result in 8,500 shares of stock and $402,500 in debt. Plan II would result in 12,000 shares of stock and $280,000 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 $54,500. 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.)
Cooke Co. is comparing two different capital structures. Plan I would result in 8,500 shares of stock and $402,500 in debt. Plan II would result in 12,000 shares of stock and $280,000 in debt. The interest rate on the debt is 11 percent.
Explanation / Answer
Requirement 1
EPS = ( EBIT – Interest)/ no. of shares
Plain I EPS = (54500 – 402,500 x 0.11)/8500
= 10,225/8500
= 1.2029
Plain II EPS = (54500 – 280,000 x 0.11)/13500
= 23,700/12000
= 1.975
All equity EPS = (54500 – 0 x 0.11)/ 20000
= 2.725
Requirement 2:
Part A:
For breakeven EBIT, EPS of two plans should be the same.
Plan I EPS = All Equity EPS
(EBIT -44,275)/8500 = (EBIT -0)/ 20,000
200 EBIT – 85EBIT = 8855000
EBIT= 77000
Part B:
For breakeven EBIT, EPS of two plans should be the same.
Plan II EPS = All Equity EPS
(EBIT -30,800)/12,000 = (EBIT -0)/ 20,000
20 EBIT – 616,000 = 12 EBIT
EBIT= 77000
Requirement III
For breakeven EBIT, EPS of two plans should be the same.
Plan I EPS = Plan II EPS
(EBIT -44,275)/8500 = (EBIT -30,800)/12,000
EBIT = $77,000