Principles of Managerial Finance

554 PART 4 Long-Term Financial Decisions

LG3 LG4 LG5

LG6

d. Using the EPS developed in partc,the estimates of required return,ks, and

Equation 12.12, estimate the value per share at various levels of indebtedness.

Mark the level of indebtedness that results in the maximum price per share,P 0.

e. Prepare a recommendation to the board of directors of Morales Publishing,

Inc., that specifies the degree of indebtedness that will accomplish the firm’s

goal of optimizing shareholder wealth. Use your findings in parts athrough d

to justify your recommendation.

12 – 24 Integrative—Optimal capital structure Country Textiles, which has fixed oper-

ating costs of $300,000 and variable operating costs equal to 40% of sales, has

made the following three sales estimates, with their probabilities noted.

The firm wishes to analyze five possible capital structures—0, 15, 30, 45, and

60% debt ratios. The firm’s total assets of $1 million are assumed to be con-

stant. Its common stock has a book value of $25 per share, and the firm is in the

40% tax bracket. The following additional data have been gathered for use in

analyzing the five capital structures under consideration.

a. Calculate the level of EBIT associated with each of the three levels of sales.

b. Calculate the amount of debt, the amount of equity, and the number of

shares of common stock outstanding for each of the capital structures being

considered.

Capital structure Before-tax cost Required

debt ratio of debt, kd return, ks

0% 0.0% 10.0%

15 8.0 10.5

30 10.0 11.6

45 13.0 14.0

60 17.0 20.0

Sales Probability

$ 600,000 .30

900,000 .40

1,200,000 .30

Debt EPS ks P 0

0%  10.0% 

(^10)  10.3 
(^20)  10.9 
(^30)  11.4 
(^40)  12.6 
(^50)  14.8 
(^60)  17.5