a company has 250 000 outstanding common shares and 100 000 preferred stock with

Question

a company has 250 000 outstanding common shares and 100 000 preferred stock with a dividend of 2$ per share. new project costing 900 000 is being considered. there are 1 financing option.

50% through a 6% bond. 50% through a 7% bond

write the EPS show work

what EBIT would give zero EPS

this was all the information provided. how can i proceed. should i just write not enough information was provided. can you make up a price for common shares and go through the process so i can at least see it. thank you so much

Explanation / Answer

Answer: an EBIT of $ 258,500 would give zero EPS.

Workings:

EPS = [ EBIT - Interest Expense - Preferred Dividend] / Outstanding Common Shares.

Interest expense on 6% bond = $ 900,000 x 50% x 6% = $ 27,000.

Interest expense on 7% bond = $ 900,000 x 50% x 7% = $ 31,500.

Total interest expense = $ 27,000 + $ 31,500 = $ 58,500.

No information as to the tax rate.

Preferred dividend = 100,000 x $ 2 = $ 200,000.

Let the EBIT for zero EPS be E.

[ ( E - $ 58,500) - $ 200,000] / 250,000 outstanding common shares = 0

or E = $ 200,000 + $ 58,500 = $ 258,500.

If the corporate tax rate was 30 %, the equation would be modified as follows:

{ [ ( E - $ 58,500) x ( 1 - 0.30 ) ] - $ 200,000 } / 250,000 = 0

or [ ( 0.70 E - $ 40,950 ) - $ 200,000 ] / 250,000 = 0

or 0.70 E = $ 240,950.

or E = $ 240,950 / 0.70 = $ 344,215.

At an EBIT level of $ 344,215, EPS would be zero.

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