Question

2. An all-equity firm currently has 2,000,000 shares of stock outstanding and is considering borrowing $6,000,000 at 8% and buying back one-half of those shares. What is the break-even EBIT assuming a tax rate of zero? what is its EPS (a) before; and (b) after borrowing the $600,000 if its tax rate is zero and its EBIT is $1,000,000? For the firm what is its EPS (a) before; and (b) after borrowing the $600,000 if its tax rate is zero and its EBIT is $800,000?

Answer 1

Break even EBIT is the level of EBIT where EPS is 0.

EPS shall be 0 if the EBIT shall be Equal to the amount of interest.

Hence Break even EBIT =8% of 6000000

=480000

Calculation of EPS Before and after borrowing $600000 if EBIT is $1000000

EPS(after borrowing)=Earning after Interest and tax/No of shares

EPS (Before Borrowing)= 1000000/2000000

=.5

EPS(after borrowing) =(1000000-48000)/1000000

=.952

Calculation of EPS Before and after borrowing $600000 if EBIT is $800000

EPS(before Borrowing) = (800000)/200000

=.4

EPS(after borrowing) = (800000-48000)/1000000

=.752

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