Billy\'s is currently an all equity firm that has 150000 shares of stock outstan

Question

Billy's is currently an all equity firm that has 150000 shares of stock outstanding at a market price of $39.36 a share. The firm has decided to leverage its operations by issuing $100000 of debt at an interest rate of 4.5 percent. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that must be achieved in order for this to occur (that is, what is the breakeven EBIT?) Ignore taxes.  

Explanation / Answer

Let Break-even EBIT be $x

All Equity Plan:

Number of shares outstanding = 150,000
Current Price of share = $39.36

EPS = EBIT / Number of shares outstanding
EPS = $x / 150,000

Levered Plan:

Value of Debt = $100,000
Interest Rate = 4.5%
Interest Expense = 4.5%*$100,000 = $4,500

Number of shares repurchased = $100,000 / $39.36
Number of shares repurchased = $2,541

Number of shares outstanding = 150,000 - 2,541
Number of shares outstanding = 147,459

EPS = (EBIT - Interest Expense) / Number of shares outstanding
EPS = ($x - $4,500) / 147,459

EPS under All equity plan = EPS under levered plan
$x / 150,000 = ($x - $4,500) / 147,459
147,459 * $x = 150,000 * $x - $675,000,000
$675,000,000 = 2,541 * $x
$x = $265,643.45

So, Break-even EBIT is $265,643.45

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.