Corporate_Finance_9th_edition_Solutions_Manual_FINAL0

1030000 interest cash flow 3000 the investor should

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Unformatted text preview: under this capitalization will be: EPS = $750,000/240,000 shares EPS = $3.13 Under Plan II, the levered company, EBIT will be reduced by the interest payment. The interest payment is the amount of debt times the interest rate, so: NI = $750,000 – .10($3,100,000) NI = $440,000 344 345 And the EPS will be: EPS = $440,000/160,000 shares EPS = $2.75 Plan I has the higher EPS when EBIT is $750,000. b. Under Plan I, the net income is $1,500,000 and the EPS is: EPS = $1,500,000/240,000 shares EPS = $6.25 Under Plan II, the net income is: NI = $1,500,000 – .10($3,100,000) NI = $1,190,000 And the EPS is: EPS = $1,190,000/160,000 shares EPS = $7.44 Plan II has the higher EPS when EBIT is $1,500,000. c. To find the breakeven EBIT for two different capital structures, we simply set the equations for EPS equal to each other and solve for EBIT. The breakeven EBIT is: EBIT/240,000 = [EBIT – .10($3,100,000)]/160,000 EBIT = $930,000 5. We can find the price per share by dividing the amount of debt used to repurchase shares by the number of shares repurchased. Doing so, we find the share price is: Share price = $3,100,000/(240,000 – 160,000) Share price = $38.75 per share The value of the company under the all-equity plan is: V = $38.75(240,000 shares) = $9,300,000 And the value of the company under the levered plan is: V = $38.75(160,000 shares) + $3,100,000 debt = $9,300,000 346 6. a. The income statement for each capitalization plan is: EBIT Interest NI EPS I $12,000 2,000 $10,000 $ 6.67 II $12,000 3,000 $9,000 $ 8.18 All-equity $12,000 0 $12,000 $ 5.22 Plan II has the highest EPS; the all-equity plan has the lowest EPS. b. The breakeven level of EBIT occurs when the capitalization plans result in the same EPS. The EPS is calculated as: EPS = (EBIT – RDD)/Shares outstanding This equation calculates the interest payment (RDD) and subtracts it from the EBIT, which results in the net income. Dividing by the shares outstanding gives us the EPS. For the allequity capital structure, the interest paid is zero. To find the breakeven EBIT for two different capital structures, we simply set the equations equal to each other and solve for EBIT. The breakeven EBIT between the all-equity capital structure and Plan I is: EBIT/2,300 = [EBIT – .10($20,000)]/1,500 EBIT = $5,750 And the breakeven EBIT between the all-equity capital structure and Plan II is: EBIT/2,300 = [EBIT – .10($30,000)]/1,100 EBIT = $5,750 The break-even levels of EBIT are the same because of M&M Proposition I. c. Setting the equations for EPS from Plan I and Plan II equal to each other and solving for EBIT, we get: [EBIT – .10($20,000)]/1,500 = [EBIT – .10($30,000)]/1,100 EBIT = $5,750 This break-even level of EBIT is the same as in part b again because of M&M Proposition I. 347 d. The income statement for each capitalization plan with corporate income taxes is: EBIT Interest Taxes NI EPS I $12,000 2,000 4,000 $6,000 $ 4.00 II $12,000 3,000 3,600 $5,400 $ 4.91 All-equity $12,000 0 4,800 $7,200 $ 3.13 Plan II still has the highest EPS; the all-equity plan still has the lowest EPS. We can calculate the EPS as: EPS = [(EBIT – RDD)(1 – tC)]/Shares outstanding This is similar to the equation we used before, except that now we need to account for taxes. Again, the interest expense term is zero in the all-equity capital structure. So, the breakeven EBIT between the all-equity plan and Plan I is: EBIT(1 – .40)/2,300 = [EBIT – .10($20,000)](1 – .40)/1,500 EBIT = $5,750 The breakeven EBIT between the all-equity plan and Plan II is: EBIT(1 – .40)/2,300 = [EBIT – .10($30,000)](1 – .40)/1,100 EBIT = $5,750 And the breakeven between Plan I and Plan II is: [EBIT – .10($20,000)](1 – .40)/1,500 = [EBIT – .10($30,000)](1 – .40)/1,100 EBIT = $5,750 The break-even levels of EBIT do not change because the addition of taxes reduces the income of all three plans by the same percentage; therefore, they do not change relative to one another. 348 7. To find the value per share of the stock under each capitalization plan, we can calculate the price as the value of shares repurchased divided by the number of shares repurchased. The dollar value of the shares repurchased is the increase in the value of the debt used to repurchase shares, or: Dollar value of repurchase = $30,000 – 20,000 = $10,000 The number of shares repurchased is the decrease in shares outstanding, or: Number of shares repurchased = 1,500 – 1,100 = 400 So, under Plan I, the value per share is: P = $10,000/400 shares P = $25 per share And under Plan II, the number of shares repurchased from the all equity plan by the $30,000 in debt are: Shares repurchased = 2,300 – 1,100 = 1,200 So the share price is: P = $30,000/1,200 shares P = $25 per share This shows that when there are no corporate taxes, the stockholder does not care about the capital structure decision of the firm. This is M&M Proposition I without taxes. 8. a. The earnings per share are: EPS = $37,500/5,000 shares EPS = $7.50 So, the ca...
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This note was uploaded on 07/10/2010 for the course FIN 6301 taught by Professor Eshmalwi during the Spring '10 term at University of Texas-Tyler.

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