Question

Hotel Cortez is an all-equity firm that has 125000 shares of stock outstanding at a market price of $44.46 per share. The firm's management has decided to issue $80000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 4.2 percent. What is the break-even EBIT? Ignore taxes.

Answer 1

Answer:

EBIT = $3387.42

Explanation:

At break even EBIT, both EPS are the same

EPS in case of all equity firm = EPS of leverd firm

EPS in case of all equity firm = EBIT/ 125.000

EPS of leverd firm = (EBIT-Interest) / Shares outstanding

(Shares outstanding= 125.000-80.000/44.46 = 1012.14 )

EPS of leverd firm = (EBIT - 4.2 %* 80.000 )/ 1012

=(EBIT - 3360)/ 1012

Hence

EBIT/ 125.000= (EBIT - 3.360)/ 1.012

1012 EBIT = 125.000 EBIT - 420.000.000

EBIT = $3387.42