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Capital Structure and Break Even EBIT

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A company is comparing two different capital structures:

An all equity plan (PLAN 1) and a levered plan (PLAN 2). Under plan 1 the company would have 200,000 shares of stock outstanding. Under plan 2 there would be 90,000 shares of stock outstanding and $1.5 million in debt outstanding. The interest rate on the debt is 8% and there are not taxes.

If EBIT is $150,000 which plan will result in the higher EPS?
If EBIT is $300,000 which plan will resulting the higher EPS?
What is the break even EBIT?

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Solution Summary

The solution describes the steps to determine better capital structure at different levels of EBIT. It also calculates break even level of EBIT.

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Solution:

If EBIT is $150,000 which plan will result in the higher EPS?

Plan 1
EBIT =150000
Number of shares=200,000
EPS=150000/200000=$0.75
Plan 2
EBIT =150000
Number of shares=90,000
Interest=1,500,000*8%=$120000
Net ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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