Capital Structure

Q 1.1Lambdoid Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II).Under Plan I, Lambdoid would have 200,000 shares of stock outstanding.Under Plan II, there would be 100,000 shares of stock outstanding and $4 million in debt outstanding.The interest rate on the debt is 10% and there are no taxes.

a.If EBIT is $500,000, which plan will result in higher EPS?

b.If EBIT is $3.5 million, which plan will result in higher EPS?

c.What is the break-even EBIT?

Q 1 .2The Lancet Co. is comparing two different capital structures.Plan I would result in 800 shares of stock and $14,000 in debt.Plan II would result in 900 shares of stock and $7000 in debt.The interest rate on the debt is 11%.

a.Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $5000.The all-equity plan would result in 1000 shares 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%.Are the break-even levels of EBIT different from before?Why or why not?

Q 1.3A small retailer is considering the advantages of adding debt to the business capital structure.Currently, $400,000 of assets have been financed entirely with 20,000 shares of common stock.The retailer is considering repurchase of 50% of the equity using proceeds from a bond issue that will require payment of 10% coupon interest.EBIT is projected to be $88,000 for next year, and the applicable corporate income tax rate is 40%.

a.Calculate earnings per share under the current all-equity financing and under the bond issue alternative.

b.Calculate EPS given an 80% repurchase.Should the retailer be encouraged to take on a higher debt-equity ratio?

Q 1.4American Presidential is currently financing its $250,000 million in assets with 10 million shares of common stock.American is thinking of replacing its all-equity capital structure with a new capital structure containing 10% preferred stock, 40% debt, and 50% equity.The preferred stock bears a 6% dividend rate and debt pays a coupon of 9%.Projected EBIT is $40 million and the corporate tax rate is 34%.

c.Calculate earnings per share under the current all-equity capital structure and under the alternative financing plan.

d.At what EBIT will American be indifferent between the two capital structure alternatives?

Capital Structure Homework Problems 1. Lambdoid Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Lambdoid would have 200,000 shares of stock outstanding. Under Plan II, there would be 100,000 shares of stock outstanding and $4 million in debt outstanding. The interest rate on the debt is 10% and there are no taxes. a. If EBIT is $500,000, which plan will result in higher EPS? b. If EBIT is $3.5 million, which plan will result in higher EPS? c. What is the break-even EBIT? 2. The Lancet Co. is comparing two different capital structures. Plan I would result in 800 shares of stock and $14,000 in debt. Plan II would result in 900 shares of stock and $7000 in debt. The interest rate on the debt is 11%. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $5000. The all-equity plan would result in 1000 shares 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%. Are the break-even levels of EBIT different from before? Why or why not? 3. A small retailer is considering the advantages of adding debt to the business' capital structure. Currently, $400,000 of assets have been financed entirely with 20,000 shares of common stock. The retailer is considering repurchase of 50% of the equity using proceeds from a bond issue that will require payment of 10% coupon interest. EBIT is projected to be $88,000 for next year, and the applicable corporate income tax rate is 40%. a. Calculate earnings per share under the current all-equity financing and under the bond issue alternative. b. Calculate EPS given an 80% repurchase. Should the retailer be encouraged to take on a higher debt-equity ratio? 4. American Presidential is currently financing its $250,000 million in assets with 10 million shares of common stock. American is thinking of replacing its all-equity capital structure with a new capital structure containing 10% preferred stock, 40% debt, and 50% equity. The preferred stock bears a 6% dividend rate and debt pays a coupon of 9%. Projected EBIT is $40 million and the corporate tax rate is 34%. c. Calculate earnings per share under the current all-equity capital structure and under the alternative financing plan. d. At what EBIT will American be indifferent between the two capital structure alternatives