Question

hotel cortez is an all-equity firm that has 6,400 shares of stock outstanding at a market price of $17 per share. the firm's management has decided to issue $36,000 worth of debt and use the funds to repurchase shares of the outstanding stock. the interest rate on the debt will be 9 percent. what is the break-even ebit?

Answer 1

The break-even EBIT for Hotel Cortez is $6,480.

Step-by-step explanation:

To find the break-even EBIT, we need to calculate the annual interest expense and subtract it from the firm's EBIT.

The interest expense can be calculated by multiplying the amount of debt ($36,000) by the interest rate (9%). So, the annual interest expense would be $3,240.

To break even, the EBIT must equal the interest expense. Let's assume the break-even EBIT is x. We can set up the equation: x - $3,240 = $3,240.

Solving for x, we get the break-even EBIT as $6,480.

Answer 2

Hotel Cortez plans to issue debt to repurchase shares of its outstanding stock. The break-even EBIT, or the level of earnings before interest and taxes needed to cover the interest expense on the debt, can be found by calculating the interest expense on the debt and dividing it by the difference in the market value of the outstanding stock.

Step-by-step explanation:

In this scenario, Hotel Cortez plans to issue $36,000 worth of debt and use the funds to repurchase shares of its outstanding stock. The interest rate on the debt is 9%. To find the break-even EBIT (Earnings Before Interest and Taxes), we need to calculate the interest expense on the debt and subtract it from the current EBIT.

First, let's calculate the interest expense. The amount of debt is given as $36,000, and the interest rate is 9%. Therefore, the interest expense will be $36,000 multiplied by 9%, which is $3,240.

Now, we can calculate the break-even EBIT. We know that the market price per share is $17, and there are 6,400 shares outstanding. So, the current market value of the outstanding stock is $17 multiplied by 6,400, which is $108,800. Since the firm plans to repurchase shares worth $36,000, the remaining market value of the outstanding stock after repurchase will be $108,800 minus $36,000, which is $72,800.

The break-even EBIT can be calculated by dividing the interest expense ($3,240) by the difference in market value of the outstanding stock ($72,800). Therefore, the break-even EBIT is $3,240 divided by $72,800, which is approximately 0.0446 or 4.46%.