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28 April, 08:26

Billy's is currently an all equity firm that has 115000 shares of stock outstanding at a market price of $36.22 a share. The firm has decided to leverage its operations by issuing $100000 of debt at an interest rate of 9.6 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 the firm is expecting? Ignore taxes.

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  1. 28 April, 08:56
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    So, Break-even EBIT is $265,643.45

    Explanation:

    Let Break-even EBIT be $x

    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 = 9.6%

    Interest Expense = 9.6% * $100,000 = $9600

    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 - $9600) / 147,459

    EPS under All equity plan = EPS under levered plan

    $x / 150,000 = ($x - $9600) / 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
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