Question

Integrativelong dashOptimal capital structure   The board of directors of Morales​ Publishing, Inc., has commissioned a capital structure study. The company has total assets of $40,800,000 . It has earnings before interest and taxes of $7,910,000 and is taxed at a rate of 27% .

a. Create a spreadsheet showing values of debt and equity as well as the total number of​ shares, assuming a book value of  $25 per share.

b. Given the​ before-tax cost of debt at various levels of​ indebtedness, calculate the yearly interest expenses.

c. Using EBIT of $7,910,000 ​, a 27% tax​ rate, and the information developed in parts ​(a​) and ​(b​)​, calculate the most likely earnings per share for the firm at various levels of indebtedness. Mark the level of indebtedness that maximizes EPS.

d. Using the EPS developed in part ​(c​)​, the estimates of required​ return, r Subscript s and the equation Upper P0=EPS/ rs ​, estimate the value per share at various levels of indebtedness. Mark the level of indebtedness in the following table that results in the maximum price per​ share, P0 .

e. Prepare a recommendation to the board of directors of Morales Publishing that specifies the degree of indebtedness that will accomplish the​ firm's goal of optimizing shareholder wealth. Use your findings in parts ​(a​) through ​(d​) to justify your recommendation. a. Create a spreadsheet showing values of debt and equity as well as the total number of​ shares, assuming a book value of  $ 25 per share.

Answer 1

Solution
a)	Book Value/Share $25
	A	B	C	D	E
			C=A*B	D=B-C	E=D/25
	Debt	Total Assets	Debt	Equity	No of Shares
	0%	40800000	0	40800000	1632000
	10%	40800000	4080000	36720000	1468800
	20%	40800000	8160000	32640000	1305600
	30%	40800000	12240000	28560000	1142400
	40%	40800000	16320000	24480000	979200
	50%	40800000	20400000	20400000	816000
	60%	40800000	24480000	16320000	652800
	70%	40800000	28560000	12240000	489600
	80%	40800000	32640000	8160000	326400
	90%	40800000	36720000	4080000	163200
b)	Interest on debt is assumed as 10%
	EBIT=7910000
	A	B	C	D
			C=A*B	D=C*10%
	Debt	Total Assets	Debt	Interest Expense
	0%	40800000	0	0
	10%	40800000	4080000	408000
	20%	40800000	8160000	816000
	30%	40800000	12240000	1224000
	40%	40800000	16320000	1632000
	50%	40800000	20400000	2040000
	60%	40800000	24480000	2448000
	70%	40800000	28560000	2856000
	80%	40800000	32640000	3264000
	90%	40800000	36720000	3672000
c)	EBIT=7910000
	A	B	C	D	E	F	G	H	I
			C=A*B	D=C*10%	E=EBIT-D	=E*27%	G=E-F		I=G/H
	Debt	Total Assets	Debt	Interest Expense	EBT	Tax@27%	EAT	No of shares	EPS
	0%	40800000	0	0	7910000	2135700	5774300	1632000	3.54
	10%	40800000	4080000	408000	3830000	1034100	2795900	1468800	3.73
	20%	40800000	8160000	816000	-250000	-67500	-182500	1305600	3.97
	30%	40800000	12240000	1224000	-4330000	-1169100	-3160900	1142400	4.27
	40%	40800000	16320000	1632000	-8410000	-2270700	-6139300	979200	4.68
	50%	40800000	20400000	2040000	-12490000	-3372300	-9117700	816000	5.25
	60%	40800000	24480000	2448000	-16570000	-4473900	-1.2E+07	652800	6.11
	70%	40800000	28560000	2856000	-20650000	-5575500	-1.5E+07	652800	5.65
	80%	40800000	32640000	3264000	-24730000	-6677100	-1.8E+07	652800	5.20
	90%	40800000	36720000	3672000	-28810000	-7778700	-2.1E+07	652800	4.74
	EBIT =Earnings Before Interest and Tax
	EBT=Earnings After Interest Before Tax
	EAT=Earnings After Tax
d)	Estimated Required return assumed as 15%
	A	B	C	D	E	F
						F=E/15%
	Debt	Total Assets	Debt	No of shares	EPS	Po
	0%	40800000	0	1632000	3.54	35.38
	10%	40800000	4080000	1468800	3.73	37.29
	20%	40800000	8160000	1305600	3.97	39.66
	30%	40800000	12240000	1142400	4.27	42.72
	40%	40800000	16320000	979200	4.68	46.80
	50%	40800000	20400000	816000	5.25	52.51
	60%	40800000	24480000	652800	6.11	61.08
	70%	40800000	28560000	652800	5.65	56.52
	80%	40800000	32640000	652800	5.20	51.95
	90%	40800000	36720000	652800	4.74	47.39