Question

Northeast Lobster currently has 18,400 shares of stock outstanding. It is considering issuing $94,000 of debt at an interest rate of 6.2 percent. The break-even level of EBIT between these two capital structure options is $73,000. For this to be true, what is the current stock price? Ignore taxes. $70.08 $60.79 $67.04 $63.99 $73.13

Answer 1

The break - even level of EBIT is the EBIT at which Earnings per share (EPS) under both the options would be the same.

EPS under no Debt = EBIT / No. of shares = $73,000 / 18,400 = $3.96739130434

Now, EPS under debt = EPS under no debt

or, (EBIT - Interest) / No. of shares = $3.96739130434

or, No. of shares = [ EBIT - Interest ] / $3.96739130434

or, No. of shares = [ $73,000 - ($94000 x 6.2%) ] / $3.96739130434 = 16,931.0246575

So, their are 16,931.0246575 shares under the debt option. The proceeds from debt issue will be used to repurchase the equity stock at the current market price.

No. of shares repurchased = 18400 - 16,931.0246575 = 1,468.9753425

Current stock price = Debt value / No. of shares repurchased = $94,000 / 1,468.9753425 = $63.9901823 or $63.99