Question

holly's is currently an all-equity firm that has 12,000 shares of stock outstanding at a market price of $36 a share. the firm has decided to leverage its operations by issuing $120,000 of debt at an interest rate of 7.2 percent. this new debt will be used to repurchase shares of the outstanding stock. the restructuring is expected to increase the earnings per share. what is the minimum level of earnings before interest and taxes that the firm is expecting? ignore taxes.

Answer 1

The minimum level of EBIT that Holly's firm is expecting after the restructuring should be at least $8,640, which is sufficient to cover the annual interest expenses from the new debt.

Step-by-step explanation:

To determine the minimum level of earnings before interest and taxes (EBIT) that Holly's firm is expecting, we need to understand the firm's overall financial picture after issuing the debt. The firm is issuing $120,000 in debt at a 7.2% interest rate which will be utilized to repurchase shares.

First, calculate the annual interest by multiplying the total debt by the interest rate: $120,000 * 7.2% = $8,640. Since the question ignores taxes, the EBIT must be at least equal to the interest expenses to avoid a loss. Therefore, the minimum level of EBIT that Holly's firm is expecting should be $8,640.

This question relates to corporate finance and involves understanding the impact of financial leverage on a company's earnings. In particular, it deals with how additional debt taken on by a company to repurchase shares can affect its earnings per share, assuming no taxes are involved.