Question

Room and Board is considering two capital structures that have a break-even EBIT of $24,600. The all-equity capital structure would have 15,800 shares outstanding. The levered capital structure would have 11,650 shares of stock and $86,000 of debt. What is the interest rate on the debt? Ignore taxes.

Answer 1

Rate of Interest = 7.51 %

Indifference Point

where EBIT = Indifference Level of EBIT = 24600

Int 1 = Interest in Plan 1 = 0 Int 2 = Interest in Plan 2 =?

Pref Div 1 = Preference dividend in Plan 1 = 0   Pref Div 2 = Preference dividend in Plan 2 = 0

N 1 = No of Equity Shares in plan 1 = 15800 N 2 = No of Equity Shares in plan 2 = 11650

t = 0

(24600 - 0)(1-0) - 0 / 15800 = (24600 - Int)(1-0) - 0 / 11650

(24600 * 11650)/15800 = 24600 - Int

18139 = 24600 - Int

Int = 6461

Rate of Interest = 6461 / 86000 * 100 = 7.51 %