Holly's is currently an all-equity firm that has 7,200 shares of stock outstanding at a market price of $41 a share. The firm has decided to leverage its operations by issuing $60,000 of debt at an interest rate of 7.6 percent. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes.
A) $22,435
B) $19,516
C) $26,400
D) $17,141
E) $25,020

Question

Quizplus · Accepted Answer

The minimum level of earnings before interest and taxes (EBIT) that the firm is expecting can be calculated by ensuring that the earnings per share (EPS) after restructuring is at least equal to the EPS before restructuring. The initial EPS is calculated as total earnings divided by the number of shares. After restructuring, the firm will have fewer shares due to the repurchase, and it will incur interest expenses. The EBIT must be sufficient to cover the interest and maintain or increase EPS. Calculating this gives the minimum EBIT as $22,435.

Holly's Is Currently an All-Equity Firm That Has 7,200 Shares