Question

Room and Board is considering two capital structures that have a break-even EBIT of $21,600. The all-equity capital structure would have 14,800 shares outstanding. The levered capital structure would have 10,900 shares of stock and $81,000 of debt. What is the interest rate on the debt? Ignore taxes.

7.36%

8.03%

7.03%

6.68%

6.30%

Answer 1

Break - even EBIT is the EBIT level, at which earnings per share (EPS) of both the capital structures is equal.

EPS under all - Equity = (EBIT - Interest) / No. of shares = ($21,600 - $0) / 14800 = $1.45945945945

Now, EPS under levered capital structure = EPS under all - equity

or, ($21,600 - Interest) / 10900 = $1.45945945945

or, $21,600 - Interest = $15,908.108108

or, Interest = $5,691.891892

Interest rate on debt = Interest / Total Debt = $5,691.891892 / $81,000 = 0.0703 or 7.03%