ABC, Inc. is comparing two capital structures to determine how to best ﬁnance the ﬁrm's operations. The ﬁrst option consists of 100% equity ﬁnancing. The second option is based on a debt-equity ratio
Of )40. What should ABC do if expected earnings before interest and taxes (EBIT) are less than the
Break-even level? Assume there are no taxes.
A) Select the leverage option because the debt-equity ratio is less than .50.
B) Select the leverage option since the expected EBIT is less than the break-even level.
C) Select the unlevered option since the debt-equity ratio is less than .50.
D) Select the unlevered option since the expected EBIT is less than the break-even level.
E) Cannot be determined from the information provided.

Question

Quizplus · Accepted Answer

When expected EBIT is less than the break-even level, the firm will not be able to cover its interest expense under the levered option. Therefore, the unlevered option is the best choice in this scenario.

ABC, Inc Is Comparing Two Capital Structures to Determine How to to Best