John is considering the best capital structure for his firm. Suppose there are two capital structures for him to choose from. Structure A would have 7,000 shares of stock and $160,000 in debt. Structure B would have 5,000 shares of stock and $240,000 in debt. The interest rate on the debt is 10%.
a Ignoring taxes, compare both of these structures to an all-equity structure, assuming that EBIT will be $39,000. The all-equity structure would have 11,000 shares of stock outstanding. Which of the three structures has the highest EPS? The lowest?
b In part (a), what are the break-even levels of EBIT for each structure as compared to that for an all-equity structure? Is one higher than the other? Why?
c Ignoring taxes, when will EPS be identical for Structures A and B?
d Repeat parts (a), (b) and (c) assuming that the corporate tax rate is40%. Are the break-even levels of EBIT different from before? Whyor why not?