Question

Clover Foods is considering two different capital structures. The first option consists of​ 12,000 shares of stock. The second option consists of​ 8,000 shares of stock plus​ $125,000 of debt at an interest rate of 7 percent. Tax rate is​ 20%. What is the​ break-even level of earnings before interest and taxes​ (EBIT) between these two​ options? A. ​$14,000 B. ​$21,000 C. ​$17,500 D. ​$26,250 E. ​$5,250

Answer 1

Break even EBIT is level at which EPS is same
Lets assume break even EBIT = X
Therefore
EPS option 1 =		X*(1-20%)/12000
EPS option 2 =		(X-125000*7%)*(1-20%)/8000
80%X/12000=	(X-8750)*(1-20%)/8000
6.4X=		9.6*(X-8750)
3.2X=		84000
X=		26250
answer= option D)	$      26,250