Room and Board has determined that $41,650 is the break-even level of earnings before interest and taxes for the two capital structures it is considering. The one structure consists of all equity with 15,500 shares of stock. The second structure consists of 12,500 shares of stock and $65,000 of debt. What is the interest rate on the debt?

Interest rate on debt is 12.40%

Explanation:

Since break-even EBIT $41,650 , the equation of the two capital structure can be written as below:

EPS under the first capital structure=EPS under the second capital structure

Generally EPS =EBIT/weighted average number of shares in an all equity financed structure like the first one

EPS=EBIT-(debt*interest rate)/weighted average number of shares in a mixed capital structure

$41,650/15,500=$41,650-($65000*interest rate)/12,500

by cross multiplication

41,650/15,500*12,500=41650-(65000*interest rate)

33588.71=41650-(65000*interest rate)

65000*interest rate=41650-33588.71

interest rate=(41650-33588.71)/65000

interest rate=12.40%

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