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Homework answers / question archive / A company is currently an all equity firm that has 15,000 shares of stock outstanding at a market price of $12

A company is currently an all equity firm that has 15,000 shares of stock outstanding at a market price of $12

Finance

A company is currently an all equity firm that has 15,000 shares of stock outstanding at a market price of $12.50 a share. Company management has decided to issue $60,000 worth of debt and use the funds to repurchase shares of the outstanding stock at the market price. The interest rate on the debt will be 7%. Ignoring taxes, what is the earnings per share (EPS) at the break-even level of earnings before interest and taxes (EBIT)?

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Computation of EPS:      
  Plan I Plan II  
Expected EBIT $13,125  $13,125   
Less: Interest    4200  =60000*7%
Profit before Tax $13,125  $8,925   
Less: Tax 0 0  
Earnings to Equity Shareholders $13,125  $8,925   
Number of Equity Shares 15,000 10200  =15000-(60000/12.5)
Earning per Share (EPS)  $0.88  $0.88   
       
Workings:      
Computation of Breakeven EBIT:      
EBIT / 15,000 = (EBIT - $4,200)/10,200   13125  
EBIT*10,200 = 15,000*EBIT - (15,000*$4,200)      
15,000*4,200 = (15,000* EBIT) - (EBIT * 10,200)      
 $63,000,000 = 4,800*EBIT       
EBIT = $63,000,000/4,800      
EBIT = $13,125      

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