You are comparing two possible capital structures for a firm. The first option i

Question

You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm:

a) whenever EBIT is less than $428,000. b) only when EBIT is $428,000. c) whenever EBIT exceeds $428,000. d)only if the debt is decreased by $428,000. e)only if the debt is increased by $428,000.

Explanation / Answer

C is correct. Breakeven EBIT is the EBIT which the firm will have to earn when it takes on leverage so that it has the same EPS as would have been the case if it would not have taken on leverage.

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