A Winnipeg firm is considering two separate capital structures. The first is an all equity plan consisting of 25,000 shares of stock. The second plan would consist of 10,000 shares of stock and $90,000 in debt at a cost of 8%. Ignore taxes. What is the break-even EBIT?
A) $12,000
B) $15,000
C) $18,000
D) $19,000
E) $21,000

Question

Quizplus · Accepted Answer

The break-even EBIT is the level of EBIT at which the firm is indifferent between the two capital structures. At this level of EBIT, the EPS will be the same under both capital structures.Under the all-equity plan, the EPS will be:EPS = EBIT / 25,000 sharesUnder the debt-equity plan, the EPS will be:EPS = (EBIT - $90,000 * 8%) / 10,000 sharesSetting these two EPS equations equal to each other, we get:EBIT / 25,000 shares = (EBIT - $90,000 * 8%) / 10,000 sharesSolving for EBIT, we get:EBIT = $12,000

A Winnipeg Firm Is Considering Two Separate Capital Structures