FIN 401 Lecture Notes - Lecture 9: Financial Distress, Capital Structure, Liquidating Distribution

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8 Jan 2018

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Value of equity e= vl d cost of equity re = ru + (ru rd) *(d/e) *(1- Cost of capital with d/e=1 re = ru + (ru rd) *(d/e)*(1-tc) To calculate d/e ratio, calculate: 1)vu ,vl, e, d/e. Ex. 5: break-even ebit, case ii mtpv corp. , currently an all-equity firm with 1,400 shares outstanding, is comparing two different potential capital structures. Plan i: 1,100 shares of stock and ,500 in debt. Ii: 900 shares of stock and ,500 in debt. The interest rate on the debt is 10%. The breakeven level of ebit occurs when the two capital structures result in the same eps. Eps = (ebit interest) *(1- tc)/shares outstanding. All equity vs. plan i, no tax: ebit/1,400 = (ebit tax: ebit/1,400 = (ebit 27,500*10%)/900 and break-even ebit = 16,500*10%)/1,100 break-even ebit = 7,700 all equity vs. plan ii, no. Financial distress: if it is facing significant problems in meeting its debt obligation.

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Cooke Co. is comparing two different capital structures. Plan I would result in 10,500 shares of stock and $296,000 in debt. Plan II would result in 12,500 shares of stock and $222,000 in debt. The interest rate on the debt is 9 percent.

Requirement 1: Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,400. The all-equity plan would result in 18,500 shares of stock outstanding. Compute the EPS for each plan. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

EPS Plan I $ 2.55 Plan II $ 2.67 All-equity plan $ 2.89

Requirement 2:

(a) In Requirement (1), what is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT $ 56,948.11

(b) In Requirement (1), what is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT $

Requirement 3: Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.) EBIT $

Requirement 4: Assume the corporate tax rate is 35 percent.

(a) Compute the EPS for each plan. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).) EPS Plan I $ Plan II $ All-equity plan $

(b) What is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT $

(c) What is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not round intermediate calculations.) EBIT $ (d) At what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.) EBIT $

Please show every step for the break-even level of EBIT calculation. Thank you.

Destin Corp. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $80,000 in debt. Plan II would result in 7,500 shares of stock and $120,000 in debt. The interest rate on the debt is 8 percent.

a.	Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $50,000. The all-equity plan would result in 12,000 shares of stock outstanding. What is the EPS for each of these plans? (Round your answers to 2 decimal places. (e.g., 32.16))

	EPS
Plan I	$
Plan II	$
All equity	$

b.	In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan?

	EBIT
Plan I and all-equity	$
Plan II and all-equity	$

c.	Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II?

EBIT

d-1	Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Round your answers to 2 decimal places. (e.g., 32.16))

	EPS
Plan I	$
Plan II	$
All equity	$

d-2	Assuming that the corporate tax rate is 40 percent, what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan?

	EBIT
Plan I and all-equity	$
Plan II and all-equity	$

d-3	Assuming that the corporate tax rate is 40 percent, when will EPS be identical for Plans I and II?

EBIT

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Blue Stripes Co. is comparing two different capital structures. Plan I would result in 8,700 shares of stock and $399,000 in debt. Plan II would result in 12,500 shares of stock and $239,400 in debt. The interest rate on the debt is 11 percent. Requirement 1: Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $53,900. The all-equity plan would result in 18,200 shares of stock outstanding. Compute the EPS for each plan. (Do not include the dollar signs ($). Round your answers to 2 decimal places (e.g., 32.16).) EPS Plan I $ Plan II $ All-equity plan $ Requirement 2: (a) In req. (1), what is the break-even level of EBIT for Plan I as compared to that for an all-equity plan? (Do not include the dollar sign ($).) EBIT $ (b) In req. (1), what is the break-even level of EBIT for Plan II as compared to that for an all-equity plan? (Do not include the dollar sign ($).) EBIT $ Requirement 3: Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not include the dollar sign ($).) EBIT $

FIN 401 Lecture Notes - Lecture 9: Financial Distress, Capital Structure, Liquidating Distribution

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