Question

A company has 5.29 million common shares outstanding and $49 million of debt with an interest rate of 5.7%. The company wants to raise another $39.2 million. It can do so by selling an additional 2.645 million shares of common stock (the equity plan) or by taking out a bank loan with an interest rate of 7.5% (the debt plan). The company has no preferred stock. The corporate tax rate is 25%. At what level of EBIT would the company have the same earnings per share (EPS) under either plan? Specify the answer in $ mln., to the nearest $0.01 mln., drop the $ symbol.

Answer 1

Interest on existing debt = $49 million * 5.7% = $2.793 million

Interest on new debt = $39.2 million * 7.5% = $2.94 million

EPS of Equity Plan = EPS of Debt Plan

(EBIT-Interest) * (1-Tax rate) / Number of Shares = (EBIT-interest) * (1-Tax rate) / Number of Shares

(EBIT - $2.793) * (1 - 0.25) / (5.29 + 2.645) = (EBIT - ($2.793 + $2.94)) * (1 - 0.25) / 5.29

(EBIT - $2.793) * 0.75 / 7.935 = (EBIT - 5.733) * 0.75 / 5.29

0.75EBIT - 2.09475 / 7.935 = 0.75EBIT - 4.29975 / 5.29

(0.75EBIT - 2.09475) * 5.29 = (0.75EBIT - 4.29975) * 7.935

3.9675EBIT - 11.0812275 = 5.95125EBIT - 34.11851625

5.95125EBIT - 3.9675EBIT = 34.11851625 - 11.0812275

1.98375EBIT = 23.03728875

EBIT = 23.03728875 / 1.98375

EBIT = 11.613 million

EBIT = 11.61 million