Clover Foods is considering two different capital structures. The first option consists of 12,000 shares of...

Clover Foods is considering two different capital structures. The first option consists of 12,000 shares of stock. The second option consists of 8,000 shares of stock plus $125,000 of debt at an interest rate of 8 percent. Ignore taxes. What is the break-even level of earnings before interest and taxes (EBIT) between these two options?

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Expert Solution

Break-even is the EBIT at which EPS of both options are same

Let X be the Break-even EBIT

		Unlevered	Levered
a	EBIT	X	X
b	Less: Interest	-	10,000
c	EBT (a-b)	X	X-10000
d	Less: Tax	-	-
e	Earnings After Tax/Net income (c-d)	X	X-10000
f	Shares outstanding*	12,000	8,000
g	EPS (e/f)	X/12000	(X-10000)/8000

X/12000 = (X-10000)/8000

X-10000 = 8000X/12000

= 0.66666666666X

X-0.66666666666X = 10000

0.33333333334 X= 10000

X = 10000/0.33333333334

= 29999.9999994

= 30000

jeff jeffy answered 1 year ago

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