11. Medallion Cooling Systems, Inc., has total assets of $11,000,000, EBIT of In

Question

11. Medallion Cooling Systems, Inc., has total assets of $11,000,000, EBIT of Integrative-Optimal capital structure $1,950,000, and preferred dividends of $200,000 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 Number of common stock shares 196,000 174,000 139,000 115,000 84,000 Cost of debt, rj Required return, rs 0% 15 30 45 60 12.1% 13.2 13.9 16.1 20.1 0% 7.8 8.7 11.9 15.2 a. Calculate earnings per share for each level of indebtedness b. Use the equation Po EPS/s 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.) Debt Ratio 0% EBIT $1,950,000 Less: Interest EBT Taxes @40% Net profit Less: Preferred dividends Profits available to common stockholders $ # shares outstanding EPS 196,000 Calculate the EPS below: (Round to the nearest dollar. Round the EPS to the nearest cent.)

Explanation / Answer

Debt Ratio = Total Debt/Total Asset

Calculation of Interest Expense

Calculation of Earning Per Share

b. Equation

P0=EPS/r

c. Optimal Capital Structure would be 30% debt & 70% equity because this is the debt/equity mix that maximizes the price of the common stock

Debt Ratio Total Debt Interest Expense 0% 0 0 15% 11000,000*0.15=1650,000 1650,000*0.078= 128,700 30% 11000,000*0.30=3300,000 3300,000*0.087=287,100 45% 11000,000*0.45=4950,000 4950,000*0.119=589050 60% 11000,000*0.6=6600,000 6600,000*0.152=1003,200

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