Explore BrainMass

Explore BrainMass

    Evaluating Capital Strucutre

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Please see the attached file.

    Evaluating McGraw Industries' Capital Structure
    McGraw Industries, an established producer of printing equipment, expects its sales to remain flat for the next 3 to 5 years because of both a weak economic outlook and an expectation of little new printing technology development over that period. On the basis of this scenario, the firm's management has been instructed by its board to institute programs that will allow it to operate more efficiently, earn higher profits, and, most important, maximize share value.

    In this regard, the firm's chief financial officer (CFO), Ron Lewis, has been charged with evaluating the firm's capital structure. Lewis believes that the current capital structure, which contains 10% debt and 90% equity, may lack adequate financial leverage. To evaluate the firm's capital structure, Lewis has gathered the data summarized in the following table on the current capital structure (10% debt ratio) and two alternative capital structures?A (30% debt ratio) and B (50% debt ratio)?that he would like to consider.

    (a)Capital Structure
    Source of Capitol Current A (30% debt) B (50%
    (10% debt) debt)
    Long-term debt $1,000,000 $3,000,000 $5,000,000
    Coupon 9% 10% 12%
    Interest Rate(b)
    Common Stock 100,000 70,000 40,000
    Shares shares shares
    Return on Equity© 12% 13% 18%

    aThese structures are based on maintaining the firm's current level of $10,000,000 of total financing.
    bInterest rate applicable to all debt.
    cMarket-based return for the given level of risk.
    Problem
    On the basis of the graph in part b, which capital structure will maximize McGraw's earnings per share (EPS) at its expected level of EBIT of $1,200,000? Why might this not be the best capital structure?

    © BrainMass Inc. brainmass.com June 3, 2020, 9:42 pm ad1c9bdddf
    https://brainmass.com/business/capital-structure-and-firm-value/195690

    Attachments

    Solution Preview

    Please see the attached files.

    Evaluating McGraw Industries' Capital Structure
    McGraw Industries, an established producer of printing equipment, expects its sales to remain flat for the next 3 to 5 years because of both a weak economic outlook and an expectation of little new printing technology development over that period. On the basis of this scenario, the firm's management has been instructed by its board to institute programs that will allow it to operate more efficiently, earn higher profits, and, most important, maximize share value.

    In this regard, the firm's chief financial officer (CFO), Ron Lewis, has been charged with evaluating the firm's capital structure. Lewis believes that the current capital structure, which contains 10% debt and 90% equity, may lack adequate financial leverage. To evaluate the firm's capital structure, Lewis has gathered the data summarized in the following table on the current capital structure (10% debt ratio) and two ...

    Solution Summary

    The solution explains how to evaluate the capital struture consisting of different debt levels using earnings per share.

    $2.19

    ADVERTISEMENT