GTB, Inc., has a 25 percent tax rate and has $71,880,000 in assets, currently fi
ID: 2758350 • Letter: G
Question
GTB, Inc., has a 25 percent tax rate and has $71,880,000 in assets, currently financed entirely with equity. Equity is worth $5 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 9 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.)
State Pessimistic Optimistic Probability of state 0.55 0.45 Expected EBIT in state $ 6.00 million $ 20.00 millionExplanation / Answer
BREAK EVEN LEVEL OF EBIT
(EBIT - I1) (1 -TAX) / N1 = (EBIT - I1) (1 -TAX) / N2
I1 , I2 = INTEREST EXPENSES
I1 = $0
I2 = ($71880000 * 9%) = $6469200
N1, N2 = NUBER OF EQUITY SHARE
N1 = ($71880000 / $5) = 14376000 SHARES
N2 = ($71880000 * 75%) / $5 = 10782000
[(EBIT - $0) (1 - 0.25)] / 14376000 = [(EBIT - $6469200) (1 -0.25)] / 10782000
0.75 EBIT / 14376000 = (0.75 EBIT - $4851900) / 10782000
$8086500 EBIT = $10782000 EBIT - $69750914400000
$2695500 EBIT = $69750914400000
EBIT = $69750914400000 / $2695500
EBIT = $25876800
STATE EXPECTED EBIT (1) PROBABILITY (2) (1) * (2) PESSIMISTIC $6 MILLION 0.55 $3.3 MILLION OPTIMISTIC $20 MILLION 0.45 $9 MILLION TOTAL EXPECTED EBIT $12.3 MILLIONRelated Questions
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