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Aleja Aleja
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5 years ago
1.  Which firm is better off when EBIT is $50? Explain why.

2. At what level of EBIT are both options equal?

3. At what level of EBIT is the 50% debt the best option?
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#1
5 years ago
1.  Which firm is better off when EBIT is $50? Explain why.
Answer: At an EBIT of $50 the all equity firm will still have an EPS of $0.50 while the 50% debt firm will have earnings of zero. The reason for the all equity firm being better off at this level of EBIT is that it has no interest expense while the 50% debt firm has interest expense that requires higher earnings to recover.

2. At what level of EBIT are both options equal?
Answer: At EBIT of $100 both firms have $1 in EPS.

3. At what level of EBIT is the 50% debt the best option?
Answer: At any EBIT above $100 the debt firm is generating higher returns (EPS). The leverage begins to pay off once breakeven is reached.
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