Question

Room and Board is considering two capital structures that have a break-even EBIT of $21,000. The all-equity capital structure would have 14,600 shares outstanding. The levered capital structure would have 10,750 shares of stock and $80,000 of debt. What is the interest rate on the debt? Ignore taxes.

Answer 1

Given,

EBIT = $21000

Unlevered shares outstanding = 14600 shares

Levered shares outstanding = 10750 shares

Debt = $80000

Solution :-

Let interest rate on the debt be 'r'

Earnings per share of unlevered capital structure = Earnings per share of levered capital structure

EBIT/unlevered shares outstanding = [EBIT - (debt x r)]/levered shares outstanding]

$21000/14600 shares = [$21000 - ($80000 x r)]/10750 shares

$21000/14600 shares x 10750 shares = $21000 - ($80000 x r)

$15462.3287671 = $21000 - ($80000 x r)

$80000 x r = $21000 - $15462.3287671

$80000 x r = $5537.6712329

r = $5537.6712329/$80000

r = 0.0692 or 6.92%