Chick 'N Fish is considering two different capital structures. The first option is an all-equity firm with22,500 shares of stock. The second option consists of 18,750 shares of stock plus $120,000 of debt at an interest rate of 7.8 percent. Ignore taxes. What is the break-even level of earnings before interest and taxes (EBIT) between these two options?

$56,150

Explanation:

EPSU= EPS

EBIT / 22,500

Therefore

[EBIT - ($120,000 × .078)] / 18,750 =$56,150

EBIT = $56,150

The break-even level of earnings before interest and taxes (EBIT) between these two options is $56,150

The missing options are below:

A. $62,813

B. $54,204

C. $60,410

D. $56,150

E. $61,290

Option D,$56,150

Explanation:

The equilibrium for both financing structure is achieved where Earning Per Share under each arrangement is the same

EPS under all equity finance =EBIT/weighted average number of shares

EPS  under the second  arrangement=EBT/weighted average number of shares

Where EBT=EBIT-(debt*interest rate)/weighted average number of shares

all equity finance has EBIT/22,500

The levered equity arrangement has EBIT-($120000*7.8%)/18750

At equilibrium:

EBIT/22,500=EBIT-($120000*7.8%)/18750

EBIT/22,500=(EBIT-9360 )/18750

We can substitute each of the options for EBIT in the equation to ascertain which one makes the two sides of equation the same:

For instance let substitute $56,150 for EBIT

56150/22,500=$2.50 in EPS

(56150-9360 )/18750=$.2.50 in EPS

Ultimately $56,150 is the break-even level of earnings

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