Angela's Quilt Shop is currently an all equity ﬁrm that has 5,000 shares of stock outstanding at a market price of $32 a share. Company management has decided to issue $100,000 worth of debt
And use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will
Be 7.5%. What are the earnings per share at the break-even level of earnings before interest and
Taxes? Ignore taxes.

Question

Quizplus · Accepted Answer

First, we need to calculate how many shares can be repurchased with $100,000 of debt.

$100,000 / (1 - 0.075) = $107,527.64 (this is the amount of funds that can be raised with debt, accounting for the interest expense)

$107,527.64 / $32 = 3,360.87 shares (this is the number of shares that can be repurchased with the funds raised)

After the repurchase, the new number of shares outstanding will be 5,000 - 3,360.87 = 1,639.13 shares.

Now, we need to calculate the earnings per share at the break-even level of EBIT (earnings before interest and taxes).

EBIT = Interest Expense

Therefore, the break-even EBIT can be calculated as:

EBIT = $100,000 x 0.075 = $7,500

Now we can calculate earnings per share at the break-even level of EBIT:

Earnings per share = (EBIT - Interest Expense) / Number of shares outstanding

Earnings per share = ($7,500 - $7,500) / 1,639.13 = $0

Therefore, earnings per share at the break-even level of EBIT is $0. However, this assumes that interest is the only expense and that all other factors remain constant. Realistically, the company would need to generate some level of profit to cover other expenses such as operating costs and taxes.

The answer choices given are not all realistic, as they assume a certain level of profitability that would not be achieved at the break-even level of EBIT. The closest answer choice is B, which has an earnings per share of $2.40, but this would require a level of EBIT above the break-even point.

Angela's Quilt Shop Is Currently an All Equity ﬁRm That