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An all-equity financed firm has $300 in assets and the stock price is $25
An all-equity financed firm has $300 in assets and the stock price is $25. If the firm restructures with 15 percent debt which creates interest expense of $43 per year and the firm's tax rate is 23 percent, what is the break-even EBIT?
Expert Solution
Number of equity shares = total assets /stock price
=> $300/ $25
=>12 shares
after restructuring :(15% equity is converted to debt)
the number of shares = 12 * (1- 0.15)
=>10.2 shares
now,
EPS under all equity option = EBIT *( 1- 0.23) / 12
EPS under restructured option = [EBIT - 43] *(1- 0.23) / 10.2
EPS under both options is same under break even EBIT.
=> EBIT *( 1- 0.23) / 12 =[EBIT - 43] *(1- 0.23) / 10.2
=>0.77 EBIT / 12 = [0.77EBIT - 33.11] / 10.2
=>10.2 / 12 *[0.77 EBIT} = [0.77EBIT - 33.11]
=>0.85*[0.77EBIT] = [0.77EBIT - 33.11]
=>0.6545EBIT = 0.77 EBIT -33.11
=>0.1155 EBIT = 33.11
=>EBIT = 33.11 / 0.1155
=>EBIT = $286.67
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