Principles of Managerial Finance

CHAPTER 12 Leverage and Capital Structure 553

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12 – 23 Integrative—Optimal capital structure The board of directors of Morales Pub-

lishing, Inc., has commissioned a capital structure study. The company has total

assets of $40,000,000. It has earnings before interest and taxes of $8,000,000

and is taxed at 40%.

a. Create a spreadsheet like the one in Table 12.10 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 $8,000,000, a 40% tax rate, and the information developed in

partsaandb,calculate the most likely earnings per share for the firm at vari-

ous levels of indebtedness. Mark the level of indebtedness that maximizes EPS.

Interest No. of

% Debt EBIT expense EBT Taxes Net income shares EPS

0% $8,000,000 

10 8,000,000 

20 8,000,000 

30 8,000,000 

40 8,000,000 

50 8,000,000 

60 8,000,000 

Before-tax

% Debt $ Total debt cost of debt, kd $ Interest expense

0% $ 0.0% $

(^10)  7.5 
(^20)  8.0 
(^30)  9.0 
(^40)  11.0 
(^50)  12.5 
(^60)  15.5 
% Debt Total assets $ Debt $ Equity No. of shares @ $25
0% $40,000,000 $ $
10 40,000,000 
20 40,000,000 
30 40,000,000 
40 40,000,000 
50 40,000,000 
60 40,000,000