Cooke Co. is comparing two different capital structures. Plan I would result in
ID: 2761664 • Letter: C
Question
Cooke Co. is comparing two different capital structures. Plan I would result in 8,000 shares of stock and $429,000 in debt. Plan II would result in 13,500 shares of stock and $214,500 in debt. The interest rate on the debt is 9 percent.
Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,600. The all-equity plan would result in 19,000 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 8,000 shares of stock and $429,000 in debt. Plan II would result in 13,500 shares of stock and $214,500 in debt. The interest rate on the debt is 9 percent.
Explanation / Answer
1
Calculation of EPS:
Plan I
Plan II
All-equity plan
Debt
$ 429,000.00
$ 214,500.00
$ -
EBIT
$ 53,600.00
$ 53,600.00
$ 53,600.00
Less: Interest on Debt
$ (38,610.00)
$ (19,305.00)
(429000*9%)
(214500*9%)
EBT (A)
$ 14,990.00
$ 34,295.00
$ 53,600.00
Number of shares (B)
8000
13500
19000
EPS = A/B =
$ 1.87
$ 2.54
$ 2.82
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 - 38610) / 8000
EPS for All Equity Plan = EBIT / 19000
Hence ,
EBIT / 19000 = (EBIT - 38610) / 8000
EBIT / 2.375 = (EBIT - 38610)
EBIT = 2.375 * EBIT - 91698.75
EBIT = 91698.75 / 1.375
EBIT = 66690
Hence Break Even EBIT = $66690
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 - 19305) / 13500
EPS for All Equity Plan = EBIT / 19000
Hence ,
EBIT / 19000 = (EBIT - 19305) / 13500
EBIT / 1.40741 = (EBIT - 19305)
EBIT = 1.40741 * EBIT - 27170
EBIT = 27170 / 0.40741
EBIT = 66690
Hence Break Even EBIT = $66690
4
Calculation of level of EBIT at which EPS will be identical for Plans I and II:
EPS for Plan I = (EBIT - 38610) / 8000
EPS for Plan II = (EBIT - 19305) / 13500
Hence,
(EBIT - 19305) / 13500 = (EBIT - 38610) / 8000
(EBIT - 19305) / 1.6875 = (EBIT - 38610)
EBIT - 19305 = 1.6875* EBIT - 65154.375
0.6875 EBIT = 45849.375
EBIT = 45849.375 / 0.6875
EBIT = 66690
Hence Break Even EBIT = $66690
1
Calculation of EPS:
Plan I
Plan II
All-equity plan
Debt
$ 429,000.00
$ 214,500.00
$ -
EBIT
$ 53,600.00
$ 53,600.00
$ 53,600.00
Less: Interest on Debt
$ (38,610.00)
$ (19,305.00)
(429000*9%)
(214500*9%)
EBT (A)
$ 14,990.00
$ 34,295.00
$ 53,600.00
Number of shares (B)
8000
13500
19000
EPS = A/B =
$ 1.87
$ 2.54
$ 2.82
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 - 38610) / 8000
EPS for All Equity Plan = EBIT / 19000
Hence ,
EBIT / 19000 = (EBIT - 38610) / 8000
EBIT / 2.375 = (EBIT - 38610)
EBIT = 2.375 * EBIT - 91698.75
EBIT = 91698.75 / 1.375
EBIT = 66690
Hence Break Even EBIT = $66690
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 - 19305) / 13500
EPS for All Equity Plan = EBIT / 19000
Hence ,
EBIT / 19000 = (EBIT - 19305) / 13500
EBIT / 1.40741 = (EBIT - 19305)
EBIT = 1.40741 * EBIT - 27170
EBIT = 27170 / 0.40741
EBIT = 66690
Hence Break Even EBIT = $66690
4
Calculation of level of EBIT at which EPS will be identical for Plans I and II:
EPS for Plan I = (EBIT - 38610) / 8000
EPS for Plan II = (EBIT - 19305) / 13500
Hence,
(EBIT - 19305) / 13500 = (EBIT - 38610) / 8000
(EBIT - 19305) / 1.6875 = (EBIT - 38610)
EBIT - 19305 = 1.6875* EBIT - 65154.375
0.6875 EBIT = 45849.375
EBIT = 45849.375 / 0.6875
EBIT = 66690
Hence Break Even EBIT = $66690