Lester's Meat Market is currently an all equity ﬁrm that has 24,000 shares of stock outstanding at a market price of $25 a share. The ﬁrm has decided to leverage its operations by issuing $200,000
Of debt at an interest rate of 8%. This new debt will be used to repurchase shares of the
Outstanding stock. The restructuring is expected to increase the earnings per share. What is the
Minimum level of earnings before interest and taxes that the ﬁrm is expecting? Ignore taxes.
A) $48,000
B) $52,400
C) $57,620
D) $60,200
E) $61,340

Question

Quizplus · Accepted Answer

The minimum level of earnings before interest and taxes (EBIT) is calculated by ensuring that the earnings per share (EPS) after restructuring is at least equal to the EPS before restructuring. The firm initially has 24,000 shares at $25 each, totaling $600,000 in equity. By issuing $200,000 in debt, the firm will repurchase $200,000 / $25 = 8,000 shares, leaving 16,000 shares. The interest on the debt is $200,000 * 8% = $16,000. To maintain the same EPS, EBIT must cover the interest and provide the same earnings per share as before. Solving for EBIT gives $48,000.

Lester's Meat Market Is Currently an All Equity ﬁRm That