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10 December, 07:01

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.

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  1. 10 December, 10:26
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    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
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Home » Business » 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.
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