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6. A company currently has 1,000 ordinary shares in issue and no debt. It has the choice of raising an additional $100,000 by issuing long-term debt at a 9% annual interest rate, or issuing 500 ordinary shares. The company has a 40% tax rate.
What level of earnings before interest and taxes would result in the same earnings per share for the two financing options?
A.$27,000
B.$21,000
C.$18,000
D.$10,800Hi Sir, this is a study hub question which after several attempts, im defeated. I dont understand how they got the answer, which is A. Could you kindly assist?
If the company issues 500 additional shares, the total number of shares will be 1,500.
It issues $100,000 of debt at 9% interest, the annual interest expense will be $9,000.
EPS FOR EQ = (EBIT * 0.6) / 1,500EPS FOE DEBT = (EBIT – 9,000) * 0.6 / 1,000
Set the two EPS equations equal to each other and solve for EBIT:
(EBIT * 0.6) / 1,500 = ((EBIT – 9,000) * 0.6) / 1,000EBIT / 2,500 = (EBIT – 9,000) / 1,000
1,000 * EBIT = 1,500 * (EBIT – 9,000)
1,500 * EBIT – 1,000 * EBIT = 13,500,000
500 * EBIT = 13,500,000
EBIT = 27,000Oh.. it was just equating the two together. Thank you sir, much appreciated 🙂
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