Question

Northeast Lobster currently has 20,300 shares of stock outstanding. It is considering issuing $208,000 of debt at an interest rate of 7.9 percent. The break-even level of EBIT between these two capital structure options is $149,000. For this to be true, what is the current stock price? Ignore taxes.

Multiple Choice

$88.26

$101.76

$92.91

$106.18

$97.33

Answer 1

At the break-even EBIT level:

[EBIT/Original No. of Shares] = [(EBIT - Interest) / New No. of Shares]

[$149,000 / 20,300] = [{$149,000 - ($208,000 x 0.079)} / X]

$7.34 = $132,568 / X

X = $132,568 / $7.34 = 18,061.28 shares

Shares Repurchased = Original No. of Shares - New No. of Shares

= 20,300 - 18,061.28 = 2,238.72 shares

We can find the price per share by dividing the amount of debt used to repurchase shares by the number of shares repurchased. Doing so, we find the share price is:

Share price = $208,000 / 2,238.72 = $92.91

Hence, Option "C" is correct.