A firm is considering two different capital structures.The first option is an all-equity firm with 75,000 shares of stock.The second option is 50,000 shares of stock plus some debt.Ignoring taxes, the break-even level of earnings before interest and taxes between these two options is $95,000.How much money is the firm considering borrowing if the interest rate is 8 percent?
A)$353,519
B)$395,833
C)$386,852
D)$400,186
E)$403,519

Question

Quizplus · Accepted Answer

The break-even EBIT is where the earnings per share (EPS) are the same for both capital structures. For the all-equity firm, EPS = EBIT / 75,000. For the mixed structure, EPS = (EBIT - Interest) / 50,000. Setting these equal and solving for the interest gives: $95,000 / 75,000 = ($95,000 - Interest) / 50,000. Solving for Interest gives Interest = $95,000 - ($95,000 * 50,000 / 75,000) = $31,666.67. Since Interest = Debt * 0.08, Debt = $31,666.67 / 0.08 = $395,833.33.

A Firm Is Considering Two Different Capital Structures