Problem: 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.
Q1. 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?
Q2. In part (1) 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?
Q3. Ignoring taxes, when will EPS be identical for Plans I and II?
Q4. Repeat parts (1), (2), and (3) assuming that the corporate tax rate is 40 percent. Are the break-even levels of EBIT different from before? Why or why not?