Integrative Optimal capital structure Medallion Cooling Systems, Inc., has total assets of $9,400,000, EBIT of $2,010,000, and preferred dividends of $199,000 and is taxed at a rate of 40%.
In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:
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Capital Structure
Debt Ratio
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Cost of Debt
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Number of Common stock shares
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Required Return
|
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0%
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0%
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202,000
|
11.7%
|
|
15
|
7.8
|
173,000
|
13.2
|
|
30
|
9.2
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136,000
|
13.8
|
|
45
|
11.9
|
110,000
|
15.9
|
|
60
|
14.9
|
80,000
|
19.9
|
a. Calculate earnings per share for each level of indebtedness.
b. Use the equation Upper P 0 equals EPS divided by r Subscript sP0=EPS/rs and the earnings per share calculated in part ?(a?) to calculate a price per share for each level of indebtedness.
c. Choose the optimal capital structure. Justify your choice.
Debt Ratio 0%
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EBIT
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$
|
|
Less: Interest
|
$
|
|
EBT
|
$
|
|
Taxes @40%
|
$
|
|
Net Profit
|
$
|
|
Less: Preferred Dividends
|
$
|
|
Profits Availiable to common stock holders
|
$
|
|
# of shares outstanding
|
$
|
|
EPS
|
$
|