AA Tours is comparing two capital structures to determine how to best finance its operations.The first option consists of all equity financing.The second option is based on a debt-equity ratio of 0.45.What should AA Tours do if its 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 0.50
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 0.50
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, it is not advisable to have any debt financing as the interest obligation will increase the company's losses. Thus, AA Tours should select the all equity financing option, also known as the unlevered option. Therefore, option D is the correct answer.

AA Tours Is Comparing Two Capital Structures to Determine How