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.

Question

Quizplus · Accepted Answer

The minimum level of earnings before interest and taxes (EBIT) that the firm is expecting can be calculated by finding the break-even point where the earnings per share (EPS) before and after the restructuring are equal. Before restructuring, the firm is all equity with no debt. After restructuring, the firm will use $200,000 of debt at an 8% interest rate to repurchase shares. The annual interest expense will be $200,000 * 8% = $16,000.To find the number of shares repurchased, we use the repurchase amount and the share price: $200,000 / $25 = 8,000 shares. So, after the repurchase, the firm will have 24,000 - 8,000 = 16,000 shares outstanding.For the EPS to remain unchanged after restructuring, the earnings available to shareholders (EBIT - interest) must be the same on a per-share basis before and after the restructuring. Let EBIT = X. Before restructuring, the EPS is X / 24,000. After restructuring, the EPS is (X - $16,000) / 16,000. Setting these equal to each other to find the break-even EBIT:X / 24,000 = (X - $16,000) / 16,000Solving for X gives:X = $48,000Therefore, the minimum level of EBIT the firm is expecting is $48,000.

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