GTB, Inc., has a 20 percent tax rate and has $85,836,000 in assets, currently fi
ID: 2456595 • Letter: G
Question
GTB, Inc., has a 20 percent tax rate and has $85,836,000 in assets, currently financed entirely with equity. Equity is worth $6 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: The firm is considering switching to a 25-percent-debt capital structure, and has determined that it would have to pay a 12 percent yield on perpetual debt in either event. What will be the break-even level of EBIT? (Enter your answer in dollars, not in millions. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)Explanation / Answer
Answer:
Total Assets = Total Equity = $85,836,000
Proposed debt = $85,836,000*25% = $21,459,000
Interest on debt = $21,459,000 *12% = $2,575,080
No of equity shares outstanding with debt in capital structure = ($85,836,000*75%)/$6 = 10,729,500 shares
No. of equity shares with out debt = $85,836,000/Market value of shares = $85,836,000/$6 = 14,306,000 shares
AT break even point:
(EBIT - Interest1)/ no of shares1 = (EBIT - Interest2)/ no of shares2
=> (EBIT - 0)/ 14,306,000 = (EBIT - $2,575,080)/ 10,729,500
=> (EBIT/14,306,000) * 10,729,500 = (EBIT - $2,575,080)
=> 0.75 EBIT = EBIT - $2,575,080 => EBIT - 0.75 EBIT = $2,575,080=> EBIT = $2,575,080/0.25 = $10,300,320 (ans)
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