A firm is considering two different capital structures.The first option is an all-equity firm with 110,000 shares of stock.The second option is 75,000 shares of stock plus some debt.Ignoring taxes, the break-even level of earnings before interest and taxes between these two options is $136,000.How much money is the firm considering borrowing if the interest rate is 8 percent?
A)$542,576
B)$540,909
C)$575,909
D)$584,243
E)$592,576

Question

Quizplus · Accepted Answer

The break-even EBIT is where the earnings per share (EPS) are the same for both capital structures. The difference in the number of shares is 35,000 (110,000 - 75,000). The interest expense at break-even EBIT is $136,000 * 0.08 = $10,880. Therefore, the debt amount is $10,880 / 0.08 = $540,909.

A Firm Is Considering Two Different Capital Structures