EBIT-EPS and capital structure Data-Check is considering two capital structures.
The key information is shown in the following table. Assume a 40% tax rate.
Source of capital Structure A Structure B
Long-term debt $100,000 at 16% coupon rate $200,000 at 17%coupon
COMMON STOCK 4000-SHARES 2000-SHARES
a. Calculate two EBIT-EPS coordinates for each of the structures by selecting any two EBIT values and finding their associated EPS values.
b. Plot the two capital structures on a set of EBIT-EPS axes.
c. Indicate over what EBIT range, if any, each structure is preferred.
d. Discuss the leverage and risk aspects of each structure.
e. If the firm is fairly certain that its EBIT will exceed $75,000, which structure would you recommend? Why?
Integrative-Optimal capital structure Medallion Cooling Systems, Inc., has total assets of $10,000,000, EBIT of $2,000,000, 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 No. of common
debt ratio Cost of debt, stock shares Required return,
0% 0% 200,000 12%
15 8 170,000 13%
30 9 140,000 14
45 12 110,000 16
60 15 80,000 20
a. Calculate earnings per share for each level of indebtedness.
b. Use Equation 12.12 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.
The solution explains the EBIT-EPS analysis for different capital structures, including ideas on EBIT ranges, leverage and risk and optimal capital structure choice. Attached as Word to incorporate graphs.