Break- Even EBIT and Leverage [ LO1, 2] Destin Corp. is comparing two different capital structures. Plan I would result in 10,000 shares of stock and $ 90,000 in debt. Plan II would result in 7,600 shares of stock and $ 198,000 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 $ 48,000. The all-equity plan would result in 12,000 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 40 percent. Are the break- even levels of EBIT different from before? Why or why not?

Refer to the formula at the bottom of page 538 and the graph on page 539.

	I		II		All-Equity
EBIT
Interest
NI
EPS	$ -		$ -		$ -
Shares outstanding	10,000		7,600		12,000
Formula = Unlevered Firm EBIT/Shares outstanding = Levered Firm (EBIT-Interest)/ Shares outstanding					EBIT
Plan I vs. all equity					$ -
Plan II vs. all equity					$ -
The break even levels of EBIT are the same because of M&M Proposition I.
Formula = Levered Firm (EBIT-Interest)/Shares outstanding = Levered Firm (EBIT-Interest)/ Shares outstanding
Breakeven EBIT: Plan I vs. Plan II					$ -
This break-even level of EBIT is the same as in part (b) again, because of M&M
Proposition (I).
	I		II		All-equity
EBIT
Interest
EBT
Taxes
NI
EPS	$ -		$ -		$ -
Shares outstanding	10,000		7,600		12,000
Breakeven EBIT
Plan I vs. all-equity					$ -
Plan II vs. all-equity					$ -
Plan I vs. Plan II					$ -
The break-even levels of EBIT do not change because of additions of taxes reduces
the income of all three plans by the same percentage; therefore they do not change
relative to one another.