Question

Beta, Gamma, and Delta Companies are similar in every way except for their capital structures. Beta is an​ all-equity firm with ​$3,000,000 of value and 100,000 shares outstanding. Gamma is a levered firm with the same value as​ Beta, but ​$900,000 in debt at 55​% and 70,000 shares outstanding. Delta is a levered firm with the same value as both Beta and Gamma with $1,800,000 in debt at 16​% and 40,000 shares outstanding. What are the​ break-even EBITs for Beta and​ Gamma, Beta and​ Delta, and Gamma and Delta Companies if the corporate tax rate is 25% for all three​ companies?

What is the​ break-even EBIT for Beta and Gamma​ companies?

Answer 1

Calculation of breakeven level of EBIT between Beta and Gamma company

Breakeven level of EBIT is that point where, share price of both the companies are same.

Interest cost of Gamma = 900000*55%= 495000

Below equation formula is used:

(EBIT)(1-Tax). (EBIT- interest cost) (1-Tax)

___________________ =. ____________________

No. of total shares of Beta No. of Total shares of Gamma

(EBIT)*(1-0.25) (EBIT -495000)*(1-0.25)

___________________ = ____________________

100000 70000

0.75 EBIT 0.75 EBIT - 371250

______________ = ________________

100000 70000

0.75 EBIT * 70000 = 100000 * (0.75 EBIT - 371250)

52500 EBIT =. 75000 EBIT - 37125000000

22500 EBIT = 37125000000

EBIT = 1650000

so, break even level of EBIt between Beta and Gamma company is $1,650,000