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

Question

Quizplus · Accepted Answer

The break-even EBIT is calculated by setting the EBIT such that the net income is the same before and after restructuring. The interest expense is $10, and the tax shield on interest is $10 * 40% = $4. Therefore, the break-even EBIT is $10 / (1 - 0.4) = $16.67. Adding the interest expense of $10 gives $26.67, which rounds to $27. However, the closest option is $50, which suggests a miscalculation or assumption in the problem setup.

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