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Kyle Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 765,000 shares of stock outstanding. Under Plan II, there would be 515,000 shares of stock outstanding and $9.25 million in debt outstanding. The interest rate on the debt is 12 percent, and there are no taxes. a. Assume that EBIT is $2.6 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.) EPS Plan I $ Plan II $ b. Assume that EBIT is $3.1 million. Compute the EPS for both Plan I and Plan II. (Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.) EPS Plan I $ Plan II $ c. What is the break-even EBIT

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Solution :

Calculation of the [tex]$\text{EPS}$[/tex] for both [tex]$\text{plan I}$[/tex] and [tex]$\text{plan II}$[/tex] where EBIT is 2.6 million.

                                                     [tex]$\text{plan I}$[/tex]                      [tex]$\text{plan II}$[/tex]

EBIT                                          $ 2.6 million           $ 2.6 million

Less : Interest                                                          $ 1.1 million

Less

PAT                                           $ 2.6 million            $ 1.5 million

Earnings available                    $ 2.6 million            $ 1.5 million

for share holder

No. of shares                             765,000                      515,00

[tex]$\text{EPS}$[/tex] = earnings available          $ 3.40                            $ 2.9

for share holder/no. of

shares

Hence [tex]$\text{EPS}$[/tex] under the [tex]$\text{plan I}$[/tex] is $ 3.40 and [tex]$\text{plan II}$[/tex] is $ 2.91

Calculating the [tex]$\text{EPS}$[/tex] for both plan I and [tex]$\text{plan II}$[/tex] where EBIT is $ 3.1 million

                                                       [tex]$\text{plan I}$[/tex]                    [tex]$\text{plan II}$[/tex]

EBIT                                          $ 3.1 million           $ 3.1 million

Less : Interest                                                          $ 1.1 million

Less

PAT                                           $ 3.1 million            $ 2.0 million

Earnings available                    $3.1 million            $ 2.0 million

for share holder

No. of shares                            765,000                      515,00

[tex]$\text{EPS}$[/tex] = earnings available          $ 4.05                            $ 3.88

for share holder/no. of

shares

Hence, [tex]$\text{EPS}$[/tex] under the [tex]$\text{plan I}$[/tex] is [tex]$\$4.05$[/tex] and [tex]$\text{plan II}$[/tex] is [tex]$\$ 3.88$[/tex]

Calculating the breakeven EBIT

When [tex]$\text{accessing}$[/tex] the relative effectiveness leverage versus equity financing companies look for the level of the EBIT where [tex]$\text{EPS}$[/tex] remains unaffected, called the EBIT-EPS breakeven point .

To calculate the EBIT-EPS breakeven point, rearranging the [tex]$\text{EPS}$[/tex] formula:

[tex]$\text{EBIT}=\text{(EPS }\times \text{no. of common shares outstanding )}+\frac{\text{preferred share dividends}}{1-\text{tax rate}}+ \text {debt interest}$[/tex]    

        [tex]$=(\$4.05 \times 515,000)+0+\$1,100,000 = \$3,185,750$[/tex]

Therefore, the break even EBIT is $ 3,185,750  

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