An all-equity financed firm has $450 in assets and the stock price is $45. If the firm restructures with 20% debt which creates interest expense of $10 per year and the firm's tax rate is 40%, what is the break-even EBIT?

Question

Quizplus · Accepted Answer

The break-even EBIT is calculated as the interest expense divided by (1 - tax rate). Here, it is $10 / (1 - 0.4) = $16.67. However, to cover the interest and maintain the same earnings for equity holders, the EBIT must be higher. The correct calculation involves ensuring that the after-tax EBIT covers the interest, leading to a break-even EBIT of $50.

An All-Equity Financed Firm Has $450 in Assets and the Stock