A company, has EBIT of $2,000,000, total assets of $20,000,000 preferred dividends of $250,000 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, kd No. of common stock shares required return, ks
0.00% 0.00% 200,000 10.00%
15 8 170,000 11.00%
30 9 150,000 12.00%
45 12 110,000 14.00%
60 15 80,000 18.00%
Calculate earnings per share for each level of indebtedness. Use the grid for the answer
Debt Ratio 0.00% 15.00% 30.00% 45.00% 60.00%
EBIT
Less Interest
EBT
Taxes at 40%
Net Profit
Less Preferred Div
Profits avail. to Common Stockholders
Number of shares
EPS
Use the following equation P0 = EPS/ Rs (Po is the per share value, EPS is the earnings per share and Rs is the required return). Calculate the price per share for each level of indebtedness. Choose the best capital structure. Why?
Click here for the solution: A company, has EBIT of $2,000,000, total assets of $20,000,000 preferred dividends of $250,000 and is taxed at a rate of 40%
