The break-even EBIT for a company considering to restructure by issuing equity to retire debt at an interest rate of 10% with a corporate tax rate of 0% is $0.8 million. This figure represents the annual interest cost saved by the restructuring, which is the point where both plans are equivalent in terms of EBIT required.
Break-Even EBIT Calculation for Restructuring Plans
When a firm is considering restructuring its capital by issuing equity to retire debt, calculating the break-even earnings before interest and taxes (EBIT) is essential for comparing the two plans. Given the firm has $8 million in liabilities (debt) at 10% interest rate and $8 million in equity, if it retires all its debt with new equity, it changes the financial structure, thus impacting the break-even EBIT. Without taxes, the interest savings from retiring the debt would be the debt amount multiplied by the interest rate, which equals 10% of $8 million, so $0.8 million.
To calculate the break-even EBIT, one must ascertain the level of EBIT where the firm is indifferent between the two financing options. In Plan 1, with the debt, the EBIT must cover the interest expenses, which are $0.8 million. In Plan 2, without the debt, there are no interest expenses. Therefore, the break-even EBIT is when EBIT is equal to the annual interest expense of $0.8 million, because below this point, the firm would benefit from having no debt (as there would be no interest to pay), and above this point, the cost of debt is covered, and both plans are equivalent. So, the would be the break-even EBIT for both plans is $0.8 million.
for a company with a corporate tax rate of 0%, the break-even EBIT where the two financial structures are equivalent is at the level of the annual interest cost, which in this case is $0.8 million.