Question on breakeven return of an LBO
Hey Apes,
I am doing some prep and came across this question from a question bank from UMich:
Question
In an LBO, if cost of debt is 10 percent, what is the minimum return required to break even? Assume a tax rate of 30%.
Answer: Since interest is tax deductible, the break-even return is the after-tax cost of debt. Assuming tax rate of 30 percent, the break-even return is 7 percent.
Not sure how the answer could be the after tax cost of debt if we are not given the total debt and the capital structure. Maybe I'm not understanding the wording. Wouldn't the firm still need to at least produce EBITDA (assuming is a proxy of cash in this case) of 10% of the total debt to service the interest payments? I would greatly appreciate your input.
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