Question

Hotel cortez is an all-equity firm that has 12,100 shares of stock outstanding at a market price of $38 per share. the firm's management has decided to issue $74,000 worth of debt and use the funds to repurchase shares of the outstanding stock. the interest rate on the debt will be 8 percent. what is the break-even ebit? multiple choice

O $21
O $36,784
O $31,529
O $19
O $39,849

Answer 1

The break-even EBIT for Hotel Cortez is the level of earnings required to cover annual interest expenses, which in this case is $5,920.

Step-by-step explanation:

The break-even EBIT (earnings before interest and taxes) is the level of earnings at which the company's earnings are exactly sufficient to cover its interest expenses. To calculate the break-even EBIT for Hotel Cortez, we first determine the amount of shares to be repurchased with the newly issued debt and then the cost of the interest on this debt. The firm is acquiring $74,000 worth of debt at an interest rate of 8%, which results in annual interest expenses of $74,000 x 0.08 = $5,920.

Since we are looking for the EBIT that makes the earnings (after covering interest expenses) equal to zero, we set the EBIT equal to the interest expense. Therefore, the break-even EBIT for Hotel Cortez is $5,920. To find the break-even EBIT (Earnings Before Interest and Taxes), we need to determine the point at which the interest expense on the debt is equal to the amount of savings from repurchasing shares of stock.