Question

Northwestern Lumber Products currently has 24,500 shares of stock outstanding. Patricia, the financial manager, is considering issuing $177,000 of debt at an interest rate of 7.8 percent. Given this, how many shares of stock will be outstanding once the debt is issued if the break-even level of EBIT between these two capital structure options is $79,000? Ignore taxes.

Multiple Choice

17,330.05 shares

21,903.26 shares

19,207.47 shares

18,870.50 shares

20,218.39 shares

Answer 1

Answer is 20,218.39 shares

All-Equity Plan:

EBIT = $79,000
Number of shares = 24,500

EPS = (EBIT - Interest Expense) / Number of shares
EPS = ($79,000 - $0) / 24,500
EPS = $79,000 / 24,500
EPS = $3.2245

Debt Plan:

EBIT = $79,000
Value of Debt = $177,000

Interest Expense = 7.80% * Value of Debt
Interest Expense = 7.80% * $177,000
Interest Expense = $13,806

EPS = (EBIT - Interest Expense) / Number of shares
EPS = ($79,000 - $13,806) / Number of shares
EPS = $65,194 / Number of shares

EPS under All-Equity Plan = EPS under Debt Plan
$3.2245 = $65,194 / Number of shares
Number of shares = 20,218.39

So, 20,218.39 shares will be outstanding if debt is issued.