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 EPS is the same under both capital structures. Under the all-equity plan, the EPS is simply the EBIT divided by the number of shares outstanding (25,000). Under the debt plan, the EPS is the EBIT minus the interest expense (8% of $90,000 = $7,200) divided by the number of shares outstanding (10,000). Setting these two expressions equal to each other and solving for EBIT, we get:EBIT / 25,000 = (EBIT - $7,200) / 10,000EBIT = $12,000

A Winnipeg ﬁRm Is Considering Two Separate Capital Structures