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Break-Even EBIT and Leverage IBM Corp. is comparing two different capital structures. Plan I would result in 1,100 shares of stock and $16,500 in debt. Plan II would result in 900 shares of stock and $27,500 in debt. The interest rate on the debt is 10 percent.
a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $10,000. The all-equity plan would result in 1,400 shares of stock outstanding. Which of the three plans has the highest EPS? The lowest?
b. In part (a) what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? Is one higher than the other? Why?
c. Ignoring taxes, when will EPS be identical for Plans I and II?
d. Repeat parts (a), (b), and (c) assuming that the corporate tax rate is 40 percent. Are the break-even levels of EBIT different from before? Why or why not?
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The problem set deals with determining the leverage and EBIT (Earnings before interest and tax) for a company.
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