Question

Integrative-Optimal capital structure Medallion Cooling Systems, Inc., has total assets of $9,000,000, EBIT of $2,050,000, and preferred dividends of $200,000 and is taxed at a rate of 40%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment: Capital structure debt ratio Cost of debt, rd 0% 0% 15 Number of common stock shares 201,000 168,000 139,000 108,000 77,000 8.1 8.9 Required return, rs 12.2% 12.9 13.8 15.7 19.8 30 11.8 15.1 a. Calculate earnings per share for each level of indebtedness. b. Use the equation Po = EPS/rs and the earnings per share calculated in part (a) to calculate a price per share for each level of indebtedness. c. Choose the optimal capital structure. Justify your choice. a. Calculate earnings per share for each level of indebtedness. Calculate the EPS below: (Round to the nearest dollar. Round the EPS to the nearest cent.) Debt Ratio 0% EBIT $ 2,050,000 Tace. Interact

Answer 1

B C D E F G H I KL Cost of 3 Debt ratio Total Debt debt Preferred Dividend Profit available for common stocks No. of Earning common per stock shares share FBIT Interest FBT Tax @ 40% PAT Total asset * Debt ratio Total debt*cost (EBIT- of debt Interest) (EBT-TAX) A/B 0% 15% 30% 45% 60% $ $ 13,50,000 $ 27,00,000 $ 40,50,000 $ 54,00,000 0% 8.10% 8.90% 11.80% 15.10% $ 20,50,000 $ $ 20,50,000 $ $ 20,50,000 $ $ 20,50,000 $ $ 20,50,000 $ - $ 20,50,000 $8,20,000 $ 12,30,000 $ 2,00,000 $ 1,09,350 $ 19,40,650 $ 7,76,260 $ 11,64,390 $ 2,00,000 $ 2,40,300 $ 18,09,700 $ 7,23,880 $ 10,85,820 $ 2,00,000 $ 4,77,900 $ 15,72,100 $ 6,28,840 $ 9,43,260 $ 2,00,000 $ 8,15,400 $ 12,34,600 $ 4,93,840 $ 7,40,760 $ 2,00,000 $ 10,30,000 $ 9,64,390 $ 8,85,820 $ 7,43,260 $ 5,40,760 $ 2,01,000 $ 5.12 1,68,000 $ 5.74 1,39,000 $ 6.37 1,08,000 $ 6.88 77,000 $ 7.02 11 12 13 b.Calculation of price per share for each level of indebtness 14 Price per share= Earning per share / Required return 15 Earning Required per share Return Price per share 0% 15% 30% 45% 60% $ 5.124 $ 5.740 $ 6.373 $ 6.882 $ 7.023 12.20% 12.90% 13.80% 15.70% 19.80% $ $ $ $ $ 42.00 44.50 46.18 43.83 35.47 24 c. Optimal capital structure will be with debt ratio 3%, i.e.30% debt, 70% equity. 25 This is optimal as the price per share at this level is the maximum i.e $ 46.18 from other given levels of debt ratios.

А Preferred Dividend Profit available for No. of common common stocks stock shares 3 Debt ratio Total Debt Cost of debt EBIT Interest EBT Tax @ 40% ТРАТ Earning per share Total debt*cost of debt Total asset * Debt ratio (EBIT-Interest) (EBT-TAX) A/B 60 7 0.15 8 0.3 9 0.45 10 0.6 =9000000* A6 =9000000*A7 =9000000* A8 =9000000*A9 =9000000* A10 0.081 0.089 0.118 0.151 2050000 2050000 2050000 2050000 2050000 =B6*C6 =B7*07 =B8*C8 =B9*C9 =B10*010 =D6-E6 =D7-E7 =D8-E8 =D9-E9 =D10-E10 =F6*40% =F7*40% =F8*40% =F9*40% =F10*40% =F6-66 =F7-G7 =F8-G8 =F9-G9 =F10-G10 200000 200000 200000 200000 200000 =H6-16 =H7-17 =H8-18 =H9-19 =H10-110 201000 168000 139000 108000 77000 =J6/K6 =J7/K7 =J8/K8 =19/K9 =J10/K10 11 12 13 b.Calculation of price per share for each level of indebtness Price per share= Earning per share / Required return Earning per Required share Return Debt ratio Price per share 0.122 0.129 0.138 0.157 =C18/D18 =C19/019 =C20/D20 =C21/D21 =C22/D22 0.6 =L10 0.198 23 24 c. Optimal capital structure will be with debt ratio 3%,i.e.30% debt, 70% equity. 25 This is optimal as the price per share at this level is the maximum i.e $46.18 from other given levels of debt ratios.
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