Your Company Doesn't Face Any Taxes and Has $150 Million

question 67

Multiple Choice

Your company doesn't face any taxes and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 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 shown as follows:
$$\begin{array} { c c c } \text { State } & \text { Pessimistic } & \text { optimistic } & \\\text { Probability of state } & 0.3 & 0.7 \\\text { Expected EBIT in state } & \$ 15 \text { million } & \$ 40 \text { million } \end{array}$$
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the break-even EBIT?

• A) $18 million
• B) $27.5 million
• C) $32.5 million
• D) $40 million

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Definitions:

Financial Market

A marketplace where buyers and sellers engage in the trade of assets such as stocks, bonds, currencies, and derivatives.

Securities

Financial instruments representing an ownership position, a creditor relationship, or rights to ownership, such as stocks, bonds, and options.

Regulated

Controlled or governed according to rules, typically by a government agency or authority.

Financial Market

A marketplace where buyers and sellers engage in trading of financial assets such as stocks, bonds, and derivatives.