Question

Kelso Electric is an all-equity firm with 44,000 shares of stock outstanding. The company is considering the issue of $300,000 in debt at an interest rate of 6 percent and using the proceeds to repurchase stock. Under the new capital structure, there would be 27,000 shares of stock outstanding. Ignore taxes. What is the break-even EBIT between the two plans

Answer 1

Breakeven EBIT is $46,588.24

Step-by-step explanation:

Breakeven EBIT occurs where earnings per share of the two plans are equal as demonstrated 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/44,000=EBIT-(6%*$300,000)/27000

EBIT/44000=EBIT-18000/27000

By cross multiplication we have;

27000*EBIT/44000=EBIT-18000

27000EBIT=44000(EBIT-18000)

27000EBIT=44000EBIT- 792,000,000.00

44000EBIT-27000EBIT= 792,000,000.00

17000EBIT= 792,000,000.00

EBIT= 792,000,000.00/17000

EBIT=$46,588.24