Purchase Solution

# Break-Even EBIT

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Break-Even EBIT. Duval Corporation is comparing two different capital
structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I,
Duval would have 600,000 shares of stock outstanding. Under Plan II, there would
be 300,000 shares of stock outstanding and \$10 million in debt outstanding. The
interest rate on the debt is 10 percent, and there are no taxes.

a. If EBIT is \$1.5 million, which plan will result in the higher EPS?
b. If EBIT is \$11 million, which plan will result in the higher EPS?
c. What is the break-even EBIT?

6. Break-Even EBIT and Leverage. Hoobastank Co. is comparing two different
capital structures. Plan I would result in 1,000 shares of stock and \$30,000 in debt.
Plan II would result in 2,000 shares of stock and \$15,000 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 \$12,000. The all-equity plan would result in 3,000 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 38 percent.
Are the break-even levels of EBIT different from before? Why or why not?

##### Solution Summary

Break-Even EBIT is equated.

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