4.
a.
Under Plan I, the unlevered company, net income is the same as EBIT with no corporate tax. The EPS
under this capitalization will be:
EPS = $200,000/150,000 shares
EPS = $1.33
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 = $200,000 – .10($1,500,000)
NI = $50,000
And the EPS will be:
EPS = $50,000/60,000 shares
EPS = $0.83
Plan I has the higher EPS when EBIT is $200,000.
b.
Under Plan I, the net income is $700,000 and the EPS is:
EPS = $700,000/150,000 shares
EPS = $4.67
Under Plan II, the net income is:
NI = $700,000 – .10($1,500,000)
NI = $550,000
And the EPS is:
EPS = $550,000/60,000 shares
EPS = $9.17
Plan II has the higher EPS when EBIT is $700,000.
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/150,000 = [EBIT – .10($1,500,000)]/60,000
EBIT = $250,000
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 = $1,500,000/(150,000 – 60,000)
Share price = $16.67 per share
The value of the company under the all-equity plan is:
V
= $16.67(150,000 shares) = $2,500,000
And the value of the company under the levered plan is:
V = $16.67(60,000 shares) + $1,500,000 debt = $2,500,000