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# Capital Structure: University Technologies, Inc.

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University Technologies, Inc., (UTI) has a current capital structure consisting of 10 million shares of common stock, \$200 million of first-mortgage bonds with a coupon interest rate of 13 percent, and \$40 million of preferred stock paying a 5 percent dividend. In order to expand into Asia, UTI will have to undertake an aggressive capital outlay campaign, expected to cost \$200 million. This expansion can be financed either by selling 4 million new shares of common stock at a price of \$50 per share or by the sale of \$200 million of subordinated debentures at a pretax interest rate of 15 percent. The company's tax rate is 40 percent.
a. Compute the EBIT-EPS indifference point between the equity and debt financing alternatives.
b. If UTI expects next year's EBIT to be \$150 million with a standard deviation of \$ 20 million, what is the probability that the equity financing option will produce higher earnings per share than the debt financing option? (Assume that EBIT is normally distributed.)

#### Solution Preview

University Technologies, Inc., (UTI) has a current capital structure consisting of 10 million shares of common stock, \$200 million of first-mortgage bonds with a coupon interest rate of 13 percent, and \$40 million of preferred stock paying a 5 percent dividend. In order to expand into Asia, UTI will have to undertake an aggressive capital outlay campaign, expected to cost \$200 million. This expansion can be financed either by selling 4 million new shares of common stock at a price of \$50 per share or by the sale of \$200 million of subordinated debentures at a pretax interest rate of 15 percent. The company's tax rate is 40 percent.
a. Compute the EBIT-EPS indifference point between the equity and debt financing ...

#### Solution Summary

The solution explains how to calculate the EBIT-EPS indifference point

\$2.19
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## Cost of capital/capital structure/dividend policy

Problem 30
[(EBIT -26-30)(1-.4) - 2] /10 = [(EBIT -26)(1-.4) -2)] /14
After the algebra, you should get an answer of 134.33

University technologies, Inc. (UTI) has a current capital structure consisting of 10 million shares of common stock, \$200 million
of first-mortgage bonds with a coupon interest rate of 13 percent, and \$40 million of preferred stock paying a 5 percent dividend.
In order to expand into Asia, UTI will have to undertake an aggressive capital outlay campaign, expected to cost \$200 million.
This expansion can be financed either by selling 4 million new shares of cmmon stock at a price of \$50 per share or by the sale of
\$200 million of subordinated debentures at a pretax interest rate of 15%. The company's tax rate is 40 percent.

Problem 14A
East publishing Company is doing an analysis of a proposed new finance text. Using the following data:

Fixed Costs (per edition)
Development (reviews, class testing, and so on)\$18,000.00
Copyediting \$5,000.00
Selling and Promotion \$7,000.00
Typesetting \$40,000.00
Total \$70,000.00
Variable Costs (per copy)
Printing and binding \$4.20
Salespeople's commission (2% of selling price)\$0.60
Author's royalties (12% of selling price) \$3.60
Bookstore discounts (20% of selling price) \$6.00
Total \$16.00
Projected Selling price \$30.00

The company's marginal tax rate is 40 percent

a. Determine the compnay's breakeven volume for this book
i. In units 5000 copies
ii. In dollar sales

b. Determine the number of copies East must sell in order to earn an (operating) profit of \$21,000 on this text.

c. Determine the total (operating) profits at the following sales levels:
i. 3000 units
ii. 5000 units \$0
iii. 10,000 units

d. Suppose East feels that \$30.00 is too high a price to charge for the new finance text. It has examined the competitive market and determined that \$24.00 would be a better selling price. What would the breakeven volume be at this new selling price?

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