Santos Unlimited (SU) was originally unlevered with 4000 shares outstanding. How

Question

Santos Unlimited (SU) was originally unlevered with 4000 shares outstanding. However, after a major financial restructure, SU now has $39000 of debt, with an annual interest expense of 8 percent. The restructuring has reduced the number of shares to 3800. A group of shareholders of SU are not convinced that this move towards adopting financial leverage is a good idea. Their main argument is that there is now some range of EBIT, however low, that will make the shareholders worse off than before. Help understand the situation better by computing the level of earnings before interest and tax (EBIT) that would make shareholders indifferent between being unlevered (i.e. not having any debt) and levered (i.e. having debt). Assume a 30 percent corporate tax rate.

Place your answer to the nearest dollar without a dollar sign or a comma (if applicable).

Explanation / Answer

Unlevered Levered EAT EBIT x (1-t) EBIT - Intt - Tax No. of shares 4000 3800 Payoff per share holder = EAT/No of shares At Indifference point - Per share payoff should be equal in both cases EBIT x 0.7 = (EBIT - (39000 x 8%)) x 0.7 0.7 EBIT = 0.7 EBIT - (3120 X 0.7) 4000 3800 3800 x 0.7 EBIT = 4000 x (0.7 EBIT - 2184) 2660 EBIT           =             2800 EBIT - 8736000 EBIT                     = 8736000 2800 - 2660 EBIT                    = 62400 Please provide feedback…. Thanks in advance… :-)

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