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3- CD is an all equity firm that has 10,000 shares of stock outstanding at a...

3- CD is an all equity firm that has 10,000 shares of stock outstanding at a market price of $20 a share. The firm's management has decided to issue $50,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 5 percent.

a. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

Draw a graph with EPS on the vertical axis and EBIT on the horizontal axis for the all equity company and the company with leverage. Show on the graph the break-even level of earnings for the two financing alternatives.

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Expert Solution

Outstanding Shares =        10,000
Market Share Price (MSP) = $           20
Debt Issued = $    50,000
Rate of Interest (ROI) = 5%
Breakeven EBIT (Earning before Interest and taxes) would be that level will be sufficient to repay the interest charges of the debt or loan amount.
So, Breakeven EBIT = Interest charges to be paid on debt issued
= 5% of $ 50,0000
= $      2,500
Break-Even EPS would be the residual of EBIT after deducting interest and taxes.
So, in that case the Earning avaible for the equity shareholders will be zero so the EPS would also be 0.

jeff jeffy answered 3 hours ago
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