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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 $12.50 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)?
Expert Solution
| 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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