Question

A firm is considering two different capital structures. The first option is an all-equity firm with 42,000 shares of stock. The levered option is 29,000 shares of stock plus some debt. Ignoring taxes, the break-even EBIT between these two options is $56,000. How much money is the firm considering borrowing if the interest rate is 7.9 percent

Answer 1

Answer:

The amount the firm considering borrowing is $244,725.74.

Explanation:

At the break-even point, we have:

Break-even EBIT / Number of shares under all-equity = (Break-even EBIT - Interest) / Number shares under lever option ..................... (1)

Substituting all the relevant values into equation (1) and solve for interest, we have:

$56,000 / 42,000 = ($58,000 - Interest) / 29,000

$1.33333333333333 = ($58,000 - Interest) / 29,000

$1.33333333333333 * 29,000 = $58,000 - Interest

$38,666.67 = $58,000 - Interest

Interest = $58,000 - $38,666.67

Interest = $19,333.33

Therefore, we have:

Amount of debt = Interest / Interest rate = $19,333.33 / 7.9% = $244,725.74

Therefore, the amount the firm considering borrowing is $244,725.74.