[cpa1988]

Can someone please explain to me what is happening here? How are they getting the 27,000 EBIT? Please don’t judge me I haven’t had a finance class in years and I haven’t had time to read this chapter intensely, only listened to lecture.

A company currently has 1,000 shares of common stock outstanding with zero debt. It has the choice of raising an additional $100,000 by issuing 9% long-term debt, or issuing 500 shares of common stock. The company has a 40% tax rate. What level of earnings before interest and taxes (EBIT) would result in the same earnings per share (EPS) for the two financing options?

a. An EBIT of $27,000 would result in EPS of $10.80 for both.

b. An EBIT of $18,000 would result in EPS of $7.20 for both.

c. An EBIT of $10,800 would result in EPS of $7.92 for both.

d. An EBIT of $27,000 would result in EPS of $7.20 for both.

Explanation

Choice “a” is correct. Earnings before interest and taxes (EBIT) of $27,000 would produce identical EPS amounts of $10.80 under both the equity and debt financing assumptions provided in the fact pattern.

Equity Financing Debt Financing

EBIT $ 27,000 $ 27,000

Interest expense 0 (9,000)

(100,000 × 9%)

Operating income 27,000 18,000

Taxes (40%) (10,800) (7,200)

Net income 16,200 10,800

÷ Shares outstanding 1,500 1,000

EPS $10.80 $10.80

Choice “d” is incorrect. An EBIT of $27,000 produces an EPS of $10.80 for each financing choice.

Choice “b” is incorrect. An EBIT of $18,000 produces an EPS of $7.20 for equity financing and $5.40 for debt financing.

Choice “c” is incorrect. An EBIT of $10,800 produces an EPS of $4.32 for equity financing and $1.08 for debt financing.

[Tux]

Yikes! I'd like to know the answer too.

Where is this question from? I have not come across this, and I was just starting to think that I was getting a handle on the material,

I also have not taken a finance class in many years. I'm trying to cram all these formulas into my brain.

Can't wait to see others' feedback….

FAR - 86 - 2/27/14
AUD - 75 - 5/29/14
BEC - 80 - 8/31/14
REG - 89 - 2/27/15
Praise Jesus! I'm done!!

Study resources:
Becker
Wiley test bank

[cpa1988]

its in chapter 6 homework. #11 in 6.5 in becker

[Anonymous]

They're starting with the $27,000 as a given if I remember correctly. You then use that number to back into the EPS under both issuance of debt/issuance of common stock.

[cpa1988]

This is all that is given:

A company currently has 1,000 shares of common stock outstanding with zero debt. It has the choice of raising an additional $100,000 by issuing 9% long-term debt, or issuing 500 shares of common stock. The company has a 40% tax rate. What level of earnings before interest and taxes (EBIT) would result in the same earnings per share (EPS) for the two financing options?

a.

An EBIT of $27,000 would result in EPS of $10.80 for both.

b.

An EBIT of $10,800 would result in EPS of $7.92 for both.

c.

An EBIT of $27,000 would result in EPS of $7.20 for both.

d.

An EBIT of $18,000 would result in EPS of $7.20 for both.

[cpa1988]

unless you are just supposed to plug in numbers from the given answers?????

[h0wdyus]

(e -9000) x ( 1- 0.4) is the Earning after Intrest and Tax when debt is issues. where e is the EBIT

e x (1 – 0.4 ) is the Earning after Tax since there is no interest when stock is issued. where e is the EBIT

Now

EPS when Debt is issues is (e-9000) x 0.6

---

1000 shares

EPS when 500 shares issued is (e x 0.6)

---

1500 shares

So both EPS are equal

(e-9000) x 0.6 (e x .6)

---

=

---

1000 shares 1500 shares

Solve for e, it comes to 27000. Substitue 27000 earning in either side. EPS comes to 10.8

FAR - 81 29th Aug 2013
AUD - 84
REG - 82
BEC - 89 29th Aug 2014
Using Yager

FROM NJ

[h0wdyus]

spacing went crazy.. the

---

is for divide

FAR - 81 29th Aug 2013
AUD - 84
REG - 82
BEC - 89 29th Aug 2014
Using Yager

FROM NJ

[h0wdyus]

(e -9000) x ( 1- 0.4) is the Earning after Intrest and Tax when debt is issues. where e is the EBIT

e x (1 – 0.4 ) is the Earning after Tax since there is no interest when stock is issued. where e is the EBIT

Now

EPS when Debt is issues is

(e-9000) x 0.6

---

1000 shares

EPS when 500 shares issued is

(e x 0.6)

---

1500 shares

So both EPS are equal

(e-9000) x 0.6 (e x .6)

---

=

---

1000 shares 1500 shares

Solve for e, it comes to 27000. Substitue 27000 earning in either side. EPS comes to 10.8

FAR - 81 29th Aug 2013
AUD - 84
REG - 82
BEC - 89 29th Aug 2014
Using Yager

FROM NJ

[cpa1988]

THANK YOU SO MUCH

[h0wdyus]

This is more like a FAR question sitting in BEC. They are all interlinked. I hope we don't see such questions in the test.

FAR - 81 29th Aug 2013
AUD - 84
REG - 82
BEC - 89 29th Aug 2014
Using Yager

FROM NJ

[cpa1988]

yeah i hope so too, chapters 4 and 6 are not fun

[Author]

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