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Capital Structures

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TACA Financing Decision

At the end of fiscal year 2006, TACA had the following account balances on its
financial statements.
Revenues 44,282
EBIT 16,472
Interest Expense 0
Net Income After Taxes 12.599
Total Assets 69,597
Current Liabilities 22,442
Other Liabilities (Long Term) 7,051
Total Equity 40,104

• Calculate TACAs debt to assets and times interest earned ratios.
• Assume that, for the computer software industry, the average times interest earned ratio is 8:1. How much interest expense could TACA carry and still not exceed industry norms?
• Assume that TACA can borrow at an interest rate of 8% per year. What amount of interest-bearing long term debt can they carry on their balance sheet without exceeding the industry-average times interest earned ratio? At this amount of debt, calculate their new long term debt to assets ratio. (Don't forget to add in the current long term debt of 7,051.)
• Why do you suppose that TACA has such a low debt ratio? (Hint: Review the Higgins 5-Factor model.)
• As a TACA shareholder, would you favor the additional debt in the firm's capital structure? Why or why not?

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Excel file contains Solution of 3 problems related with optimal capital structure.

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