GTB, Inc., has a 25 percent tax rate and has $85,716,000 in assets, currently fi
ID: 2755970 • Letter: G
Question
GTB, Inc., has a 25 percent tax rate and has $85,716,000 in assets, currently financed entirely with equity. Equity is worth $6 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 upon 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 0.46 0.54 Expected EBIT in state $ 5.10 million $ 19.10 million The firm is considering switching to a 40-percent-debt capital structure, and has determined that it would have to pay a 9 percent yield on perpetual debt in either event. What will be the break-even level of EBIT? (Enter your answer in dollars, not in millions. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)
EBIT $
Explanation / Answer
Break Even EBIT –
It is the level of EBIT where EPS remains same under different financing plan
Currently firm is entirely financed with 100 % equity hence number of equity shares outstanding is calculated as under.
Value of Asset = Value of Equity
Value of Equity = $85,716,000
Value per share = $ 6
Hence number of equity shares = 85716,000/6
Hence of shares outstanding = 14,286,000
Proposed capital structure = 40 % debt capital
Hence Equity Capital = 60 % of capital
Total capital = 85,716,000
Debt Capital = 34,286,400
Equity = 51,429,600
Number of shares = 8,571,600 ( 60 % of earlier number of shares)
At break even EBIT
[EBIT-(34,286,400 x 0.09)] x 0.75/ 8571600= EBIT x 0.75 /14,286,000
(EBIT-3085776) x0.75 = EBIT x 0.75 x 0.60
EBIT =$ 7,714,440
Hence Break Even EBIT = $7714,440
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