Question

Galaxy Products is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 112,000 shares of stock outstanding. Under Plan II, there would be 75,000 shares of stock outstanding and $600,000 in debt. The interest rate on the debt is 6.7 percent and there are no taxes. What is the break-even EBIT?

Answer 1

Answer:

Answer explained below

Explanation:

Earnings per share (EPS) under Plan 1 = EBIT / Total no. of shares = EBIT / 112000

Earnings per share (EPS) under Plan 2 = (EBIT - Interest expense) / 75000

Interest expense = 600000 * 6.7% = 40200

Earnings per share under Plan 2 = (EBIT - 40200) / 75000

For calculating Break even EBIT, we have to set the equations for EPS under both the Plans equal:

EBIT / 112000 = (EBIT - 40200) / 75000

It gives, 75000 EBIT = 112000 (EBIT - 40200)

it gives, EBIT = 4502400000 / 37000

So, EBIT = $121686