HiLo, Inc, Doesn't Face Any Taxes and Has $100 Million in in Assets

question 3

Multiple Choice

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 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:
$$\begin{array} { c c c } \text { State } & \text { Pessimistic } & \text { optimistic } & \\\text { Probability of state } & 0.65 & 0.35 \\\text { Expected EBIT in state } & \$ 5 \text { million } & \$ 19 \text { million } \end{array}$$
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 15 percent yield on perpetual debt. What will be the break-even level of EBIT?

• A) $11.2 million
• B) $9.5 million
• C) $13.0 million
• D) $15.0 million

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Definitions:

Current Assets

Assets that are expected to be converted into cash, sold, or consumed within one year or within the normal operating cycle of a business, whichever is longer.

Reversing Entries

These are accounting journal entries that reverse a previous entry, usually made at the beginning of a new accounting period to simplify record-keeping.

Work Sheet

An informal document used by accountants and auditors for preparing financial statements and ensuring the correctness of accounts.

Post-Closing Trial Balance

A listing of all accounts and their balances after closing entries are made, serving as a check to ensure that debits equal credits.