Cooke Co. is comparing two different capital structures. Plan I would result in
ID: 2791667 • Letter: C
Question
Cooke Co. is comparing two different capital structures. Plan I would result in 9,500 shares of stock and $389,500 in debt. Plan II would result in 12,160 shares of stock and $280,440 in debt. The interest rate on the debt is 10 percent.
Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,800. 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 9,500 shares of stock and $389,500 in debt. Plan II would result in 12,160 shares of stock and $280,440 in debt. The interest rate on the debt is 10 percent.
Explanation / Answer
Interest = Debt x Interest rate
Tax = EBT x Tax rate
EPS = Net Income / No. of shares
Break-even EBIT is the level of EBIT at which EPS is equal for two plans.
Without taxes and for Plan I
EPS (Plan I) = (EBIT - Interest) / No. of shares = (EBIT - 38,950) / 9,500
For All equity, EPS (Plan II) = EBIT / No. of shares = EBIT / 19,000
=> (EBIT - 38950) / 9500 = EBIT / 19000
=> EBIT = 77,900 is the break-even for Plan I
Similarly for Plan II and All equity, Break-even EBIT = 19,000 x 28,044 / (19,000 - 12,160) = 77,900
The same is the break-even EBIT for Plan I and Plan II at which EPS for all three plans = $4.10
Cooke Plan I Plan II All Equity EBIT $ 53,800 $ 53,800 $ 53,800 Interest $ 38,950 $ 28,044 $ - Net Income $ 14,850 $ 25,756 $ 53,800 EPS $ 1.56 $ 2.12 $ 2.83 With Taxes EBIT $ 53,800 $ 53,800 $ 53,800 Interest $ 38,950 $ 28,044 $ - EBT $ 14,850 $ 25,756 $ 53,800 Tax (35%) $ 5,198 $ 9,015 $ 18,830 Net Income $ 9,653 $ 16,741 $ 34,970 EPS $ 1.02 $ 1.38 $ 1.84