Question

Mount Eve is an all equity firm that has 5,000 shares of stock outstanding at a market price of Rs 15 a share. The firm's management has decided to issue Rs 30,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 12 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

Answer 1

Answer: The earnings per share at the break-even level of earnings before interest and taxes : Rs. 1.80

Number of shares that can be repurchased = Rs. 30,000 / Rs. 15 = 2,000

Therefore, number of shares outstanding after proposed repurchase = 5,000 - 2,000 = 3,000

Interest on proposed debt = Rs. 30,000 x 12 % = Rs. 3,600

Let the break-even EBIT be E

EPS under all equity plan = E / 5,000

EPS under proposed plan = ( E - 3,600) / 3,000

At break-even,

E / 5,000 = ( E - 3,600 ) / 3,000

or 0.6 E = E - 3,600

or E = 9,000

Earnings per share at the break-even level of EBIT = Rs. 9,000 / 5,000 = Rs. 1.80

or Rs. ( 9,000 - 3,600) / 3,000 = Rs. 1.80