An unlevered firm with a market value of $1 million has 50,000 shares outstanding. The firm restructures itself by issuing 200 new par bonds with face value of $1,000 and an 8% coupon. The firm uses the proceeds to repurchase outstanding stock. In considering the newly levered versus formerly unlevered firm, what is the breakeven EBIT? Ignore Taxes

800000

540000

To find the breakeven EBIT (Earnings Before Interest and Taxes), we need to equate the earnings of the levered and unlevered firms. Let's go step by step:

1. Calculate the total face value of the newly issued bonds:
The face value of each bond is $1,000, and 200 new bonds are issued.
Hence, the total face value of the bonds = $1,000 * 200 = $200,000.

2. Calculate the annual interest expense on the bonds:
The coupon rate on the bonds is 8%.
Therefore, the annual interest expense = $200,000 * 0.08 = $16,000.

3. Calculate the interest expense per share:
Divide the annual interest expense by the number of shares outstanding:
Interest expense per share = $16,000 / 50,000 = $0.32/share.

4. Calculate the earnings of the unlevered firm:
Since it is an unlevered firm, there is no interest expense.
Therefore, the earnings of the unlevered firm are equal to the EBIT.
Earnings of the unlevered firm = EBIT.

5. Calculate the earnings of the newly levered firm:
earnings = EBIT - Interest expense.
Earnings of the newly levered firm = EBIT - $0.32/share.

6. Equate the earnings of the levered and unlevered firms:
EBIT = EBIT - $0.32/share.
This equation represents the break-even point.

7. Solve for the breakeven EBIT:
EBIT - EBIT = $0.32/share.
The EBIT term will cancel out.
$0.32/share = 0.

Therefore, the breakeven EBIT is $0.
At this breakeven point, the levered firm and the unlevered firm will have the same earnings.