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is debating between a leveraged and an unleveraged capital structure. The all equity capital structure would...

is debating between a leveraged and an unleveraged capital structure. The all equity capital structure would consist of 20,000 shares of stock. The debt and equity option would consist of 13,000 shares of stock plus $280,000 of debt with an interest rate of 8 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

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Answer #1

At breakeven ,Earning per share under Both alternatives are equal.

Earning per share = [EBIT -interest ]/number of shares outstanding           [In absence of taxes]

All Equity Debt +Equity
EBIT EBIT EBIT
Less:Interest 0 280000*8%= 22400
EBT EBIT EBIT -22400
Less:Tax 0 0
Net income EBIT EBIT -22400
Number of shares outstanding 20000 13000

NOw,

EPS 1 =EPS 2

[EBIT/20000] = [EBIT -22400]/13000

13000 EBIT /20000 = EBIT -22400

.65 EBIT = EBIT -22400

EBIT - .65 EBIT = 22400

.35 EBIT = 22400

EBIT = 22400/.35

     = 64000

break-even level of earnings before interest and taxes between these two options = $ 64000

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