Question

Kelso electric is an all-equity firm with 59,000 shares of stock outstanding. the company is considering the issue of $400,000 in debt at an interest rate of 6 percent and using the proceeds to repurchase stock. under the new capital structure, there would be 37,000 shares of stock outstanding. ignore taxes. what is the break-even ebit between the two plans? multiple choice

O $64,364
O $45,409
O $40,364
O $69,727

Answer 1

The correct answer is option 3. The break-even EBIT between the current and new capital structures is $40,364.

Step-by-step explanation:

To find the break-even EBIT between the two plans, we need to compare the net income under the current capital structure (all-equity) with the net income under the new capital structure (debt and repurchased stock).

Under the current capital structure, the net income is equal to the EBIT, and with 59,000 shares outstanding, the earnings per share (EPS) can be calculated as EBIT/59,000.

Under the new capital structure, the interest expense on the debt needs to be deducted from the EBIT to calculate the net income. With 37,000 shares outstanding, the EPS can be calculated as (EBIT - Interest Expense)/37,000.

Equating the two EPS equations and solving for EBIT, we find that the break-even EBIT is $40,364.