Question

Kelso Electric is debating between a leveraged and an unleveraged capital structure. The all equity capital structure would consist of 29,000 shares of stock. The debt and equity option would consist of 17,000 shares of stock plus $220,000 of debt with an interest rate of 6 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

Answer 1

See below

Step-by-step explanation:

Break even EBIT is when earnings per share of the two plans are equal as shown below;

EPS in the first plan = EBIT/Number of shares

There are no interest and taxes

EPS in the second plan = EBIT - (Interest rate × Debt) / Number of shares. No taxes

EBIT/29,000 = EBIT - (6% × $220,000)/17,000

EBIT/29,000 = EBIT - $13,200/17,000

Cross multiply

17,000 (EBIT) = 29,000(EBIT - $13,200)

17,000EBIT = 29,000EBIT - $382,800,000

Collect like terms

$382,800,000 = 29,000EBIT - 17,000EBIT

EBIT = $382,800,000/12,000

EBIT = $31,900