GTB, Inc., has a 31 percent tax rate and has $106 million in assets, currently f
ID: 2690642 • Letter: G
Question
GTB, Inc., has a 31 percent tax rate and has $106 million in assets, currently financed entirely with equity. Equity is worth $7 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend on which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Pessimistic Optimistic Probability of state . 40 .60 Expect EBIT in state $6.90 million $15.80 million The firm is considering switching to a 51 percent debt capital structure and has determined that they would have to pay a 13 percent yield on perpetual debt in either event. What will be the break-even level of EBIT?Explanation / Answer
option 1 when the company is all equity financed(unlevered):
value of company = value of equity = value of assts = 106 million
let EBIT = x
int =0
hence PAT = x-0.31x = 0.69x
no of shares = 106,000,000/7
hence EPS = 0.69x/(106,000,000/7 )
option 2 when debt = 51% :
EBIT = x
int = 51% 0f 106000000*13% = 7027800
hence PBT = x-7027800
PAT = (x-7027800)(1-t) = (x-7027800)*.69
value of levered company = value(unlevered) + D*T
= 106 million + 54060000*.31 = 122,758,600
MV(equity) = 122758500 - 54060000 = 68698600
hence no of shares = 68698600/7
EPS = PAT/no of shares = (x-7027800)*.69/(68698600/7 )
hence for break even EBIT:
the EPS in both cases ahould be same :
ergo,0.69x/(106,000,000/7 ) = (x-7027800)*.69/(68698600/7 )
on sloving x=$19,971,014.49
= $19.97 million
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