EBIT-EPS SENSITIVITY ANALYSIS AND INDIFFERENCE LEVEL OF EBIT

QUESTION :

Stern’s Stews, Inc., is considering a new capital structure. Its

current and proposed capital structures are the following:

CURRENT PROPOSED

Total assets $150 million $150 million

Debt 25 million 100 million

Equity 125 million 50 million

Common stock price $50 $50

Number of shares 2,500,000 1,000,000

Interest rate 12% 12%

Stern’s Stews’ president expects next year’s EBIT to be $20 million, but

it may be 25 percent higher or lower. Ignoring taxes, perform an EBIT/

eps analysis. What is the indifference level of earnings before interest

and taxes? Should Stern’s Stews change its capital structure? Why?