Question

An all equity financed company is contemplating the use of debt. Under the following scenario,

A. how much debt financing should be used, and if so why?

Debt/asset ratio(%)           Cost of equity (%)       Common stock share price ($)    EPS

          0                                       5                         20                                 _____

        10                                      6                         22                                  _____

         30                                      8                         23                                  _____

        50                                     10                        21                                  _____

60.                                     14                       20                                  _____

Answer 1

							EPS in a diff. way
Debt/Asset Ratio	Cost of equity(%)	Common stock share price	Value of Equity=MPS/Ke%	Value of Debt	EPS=MPS*Ke%	V(D)+V€	No.of common stock shares	EPS
1	2	3	4=3/2	5=4/(100-Col.1)/Col.1	6=2*3	7=4+5	8=4/3	9=4*2/8
0	5	20	400.00	0	1	400	20	1
10	6	22	366.67	40.74	1.32	407.41	17	1.32
30	8	23	287.50	123.21	1.84	410.71	13	1.84
50	10	21	210.00	210.00	2.1	420.00	10	2.1
60	14	20	142.86	214.29	2.8	357.14	7	2.8
Value of debt is calculated below:
The ratio of debt which maximises the value of firm is 50-50 , where, the firm's value is 420

D/(D+E)=0		D/(D+E)=0.5
D/(D+400)=0		D/(D+210)=0.5
D=0		D=210
D/(D+E)=0.1		D/(D+E)=0.6
D/(D+366.67)=0.1		D/(D+142.86)=0.6
D=40.74		D=214.29
D/(D+E)=0.3
D/(D+287.50)=0.3
D=123.21