Question

Southwest Sands currently has 19,400 shares of stock outstanding. It is considering issuing $89,000 of debt at an interest rate of 6.2 percent. The break-even level of EBIT between these two capital structure options is $61,000. How many shares of stock will be repurchased if the company undergoes the recapitalization? Ignore taxes.

Multiple Choice

• 1,754.90 shares

• 1,504.20 shares

• 1,667.16 shares

• 1,901.15 shares

• 1,378.85 shares

Answer 1

break-even level of EBIT is the EBIT at which EPS for both the capital structure options is same

		Unlevered	Levered
a	EBIT	61,000	61,000
b	Less: Interest (89000*6.2%)	-	5,518
c	EBT (a-b)	61,000	55,482
d	Less: Tax	-	-
e	Earnings After Tax (c-d)	61,000	55,482
f	Shares outstanding	19,400	N
g	EPS (e/f)	3.14	3.14

55842/N = 61000/19400

= 3.14432989691

N = 55482/3.14432989691

=  17645.10

Shares bought back = 19400-17645.10

= 1,754.90 shares