Blackstone, Inc. is currently an all equity firm that has 65,000 shares of stock outstanding at a market price of $22 a share. The firm has decided to leverage its operations by issuing $605,000 of debt at an interest rate of 6.5%. 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 Blackstone is expecting? Ignore taxes.

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Quizplus · Accepted Answer

The minimum level of earnings before interest and taxes (EBIT) that Blackstone is expecting can be calculated by first determining the interest expense and then finding the EBIT that would keep earnings per share (EPS) at least constant post-leveraging.1. Calculate the interest expense:Interest = $605,000 * 6.5% = $39,3252. Determine the number of shares repurchased:The amount used for repurchase = $605,000Price per share = $22Number of shares repurchased = $605,000 / $22 = 27,500 shares3. Calculate the new number of shares outstanding:Original shares = 65,000Shares repurchased = 27,500New shares outstanding = 65,000 - 27,500 = 37,500 shares4. To keep EPS at least constant, the EBIT must be such that the earnings available to the new number of shares (after paying interest) are at least equal to the original earnings per share times the new number of shares.Assuming the original EBIT is X, and ignoring taxes for simplicity, the original EPS is X/65,000. After the restructuring, the EPS should be at least (X - Interest)/37,500.Setting these equal to solve for X:X/65,000 = (X - $39,325)/37,500Multiplying both sides by the denominators to clear them gives:37,500X = 65,000(X - $39,325)Expanding and simplifying:37,500X = 65,000X - 2,555,625Solving for X:2,555,625 = 65,000X - 37,500X2,555,625 = 27,500XX = 2,555,625 / 27,500X = $92,950Therefore, the minimum level of EBIT that Blackstone is expecting is $92,950.