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Demolition Construction Services has 12,500 shares of stock outstanding and no debt. The new CFO is...

Demolition Construction Services has 12,500 shares of stock outstanding and no debt. The new CFO is considering issuing $75,000 of debt and using the proceeds to retire 2,500 shares of stock. The coupon rate on the debt is 6.8 percent. What is the break-even level of earnings before interest and taxes between these two capital structure options?

A) $16,860

B) $18,520

C) $18,240

D) $21,000

E) $15,300

Solutions

Expert Solution

Correct option is -None of the answers provided is correct (Breakeven point is equals to $ 25500)

At breakeven point ,Earning per share under Both alternative are equal.

Earning per share (in case of no taxes ) = [EBIT - interest ]/number of shares outstanding

Alternative I : [EBIT -0 ]/12500

                    = EBIT /12500      [Equation1 ]

Alternative II: [EBIT -5100]/10000                             [Equation 2]

Interest= 75000*6.8%= 5100

Number of shares outstanding = 12500-2500 = 10000

Now,

EBIT/12500 = [EBIT - 5100 ]/10000

EBIT = 12500[EBIT -5100]/10000

EBIT = 1.25 [EBIT -5100]

EBIT = 1.25 EBIT - 6375

1.25 EBIT -EBIT = 6375

.25EBIT = 6375 /.25

              = 25500

jeff jeffy answered 6 months ago
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