Question

Room and Board is considering two capital structures that have a break-even EBIT of $28,200. The all-equity capital structure would have 17,000 shares outstanding. The levered capital structure would have 12,550 shares of stock and $92,000 of debt. What is the interest rate on the debt? Ignore taxes.

A. 9.17%

B. 7.62%

C. 7.20%

D. 8.02%

E. 8.41%

Answer 1

D.8.02%.

at break even EBIT, both the capital structures will have the same EPS.

EPS of all equity plan = $28,200 / 17,000 shares

=>$1.6588.

EPS of levered capital structure = EBIT -(interest rate * debt)/ number of shares.

but at break even EBIT, both the capital structures will have equal EPS.

let interest rate be x

=>1.6588 = 28,200 -(x*92,000)]/12,550

=>20,817.94 = 28,200- (x*92,000)

=>x*92,000 = 7,382.06

=>x= 7,382.06 / 92,000

=>x=0.08024

=>8.02%.