Integrative-Optimal capital structure Medallion Cooling Systems, Inc., has total assets of $9,400,000, EBIT of $1,960,000, and preferred dividends of $199,000 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 debt ratio 0% 15 30 45 60 Debt Ratio EBIT Less: Interest EBT Taxes @40% Net profit Less: Preferred dividends Profits available to common stockholders # shares outstanding EPS Cost of debt, d 0% a. Calculate earnings per share for each level of indebtedness. b. Use the equation Po=EPS/r, 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. $ $ $ $ $ a. Calculate earnings per share for each level of indebtedness. Calculate the EPS below: (Round to the nearest dollar. Round the EPS to the nearest cent.) $ 7.9 9.1 11.9 15.3 $ $ $ 0% 1,960,000 0 1960000 784000 1176000 Number of common stock shares 199000 204,000 174,000 144,000 977000 204,000 114,000 76,000 Required return, rs 12.2% 13.2 13.8 15.8 19.8
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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