Northwestern Lumber Products currently has 15,000 shares of stock outstanding.Patricia,the financial manager,is considering issuing $120,000 of debt at an interest rate of 6.75 percent.Given this,how many shares of stock will be outstanding once the debt is issued if the break-even level of EBIT between these two capital structure options is $60,000? Ignore taxes.

Question

Quizplus · Accepted Answer

The correct answer is A.The break-even level of EBIT is the level of EBIT at which the EPS is the same under both capital structures. In this case, the break-even level of EBIT is $60,000.The EPS under the all-equity capital structure is:EPS = EBIT / Number of shares outstandingThe EPS under the debt-equity capital structure is:EPS = (EBIT - Interest expense) / Number of shares outstandingSetting these two equations equal to each other, we get:EBIT / Number of shares outstanding = (EBIT - Interest expense) / Number of shares outstandingSolving for the number of shares outstanding, we get:Number of shares outstanding = EBIT / (EBIT - Interest expense)Plugging in the given values, we get:Number of shares outstanding = $60,000 / ($60,000 - $8,100) = 12,975 sharesTherefore, the number of shares outstanding once the debt is issued will be 12,975 shares.

Northwestern Lumber Products Currently Has 15,000 Shares of Stock Outstanding