Question

Kolby Corp. is comparing 3 capital structures per below    I=10%

Plan 1      1,300 shares of stock $80,640 in debt

Plan 2      2,900 shares of stock  $19,200 in debt

Plan 3      3,400 shares of stock 0 debt

a.Ignoring taxes, compare these plans. Which has highest EPS? Lowest?

	Option 1	Option 2	Option 3
EBIT	10,500	10,500	10,500
Interest
NI
EPS

Now accounting for taxes, as a shareholder which of these options would you prefer if you were risk-averse?

	1	2	3
EBIT	10,500	10,500	10,500
Interest
EBT
Taxes
NI
EPS

Answer 1

Formula to calculate future value of annuity due
Future value of annuity due	(1+r)*P*(((1+r)^n)-1/r)
Earnings per share	Net income/No of shares outstanding
Calculation of EPS is shown below
	Option 1	Option 2	Option 3
EBIT (a)	10500	10500	10500
Interest (b) (80640*10%; 19200*10%)	$8,064	$1,920	$0
NI (a-b )	$2,436	$8,580	$10,500
EPS	$1.87	$2.96	$3.09
	(2436/1300)	(8580/2900)	(10500/3400)
In absence of tax, Option 3 would have higher EPS and option 1 would have lower EPS
Tax rate is not given and thus we would assume it to be 40%
	Option 1	Option 2	Option 3
EBIT (a)	10500	10500	10500
Interest (b) (80640*10%; 19200*10%)	$8,064	$1,920	$0
EBT (a-b) (c )	$2,436	$8,580	$10,500
Taxes @ 40% (c*40%) (d)	$974.40	$3,432.00	$4,200.00
NI (c-d)	$1,461.60	$5,148.00	$6,300.00
EPS	$1.12	$1.78	$1.85
	(1461.60/1300)	(5148/2900)	(6300/3400)
If shareholder is risk averse he would prefer option 3 where company has no debt