Klassen Corporation is an all equity ﬁrm with 170,000 shares outstanding. It is considering changing its capital structure to include debt. If it does, its shares will reduce to 90,000 and it will incur
Interest of $100,000. Given this information, calculate the indifference EBIT.

Question

Quizplus · Accepted Answer

To find the indifference EBIT, we need to find the EBIT level where the earnings per share (EPS) remain the same with and without debt.

Let's first calculate the EPS without debt:
EPS = Net Income / Number of Shares Outstanding 
Since Klassen Corporation is an all equity firm, the net income equals earnings before interest and taxes (EBIT), so:
EPS without debt = EBIT / Number of Shares Outstanding 
EPS without debt = EBIT / 170,000

Now let's calculate the EPS with debt:
EPS with debt = (EBIT - Interest) / Number of Shares Outstanding 
EPS with debt = (EBIT - $100,000) / 90,000

Since we want the EPS to be the same with and without debt, we can set these two equations equal to each other and solve for EBIT:
EPS without debt = EPS with debt 
EBIT / 170,000 = (EBIT - $100,000) / 90,000 
Solving for EBIT gives us:
EBIT = $212,500

Therefore, the indifference EBIT is $212,500, which means that Klassen Corporation could have EBIT of $212,500 whether it has debt or not and its EPS would remain the same.

Choice B is the correct answer.

Klassen Corporation Is an All Equity ﬁRm with 170,000 Shares