Principles of Managerial Finance

556 PART 4 Long-Term Financial Decisions

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Lawson expects the firm’s earnings before interest and taxes (EBIT) to

remain at its current level of $1,200,000. The firm has a 40% tax rate.

Required

a. Use the current level of EBIT to calculate the times interest earned ratio for

each capital structure. Evaluate the current and two alternative capital struc-

tures using the times interest earned and debt ratios.

b. Prepare a single EBIT–EPS graph showing the current and two alternative

capital structures.

c. On the basis of the graph in part b,which capital structure will maximize

Tampa’s earnings per share (EPS) at its expected level of EBIT of

$1,200,000? Why might this notbe the best capital structure?

d. Using the zero-growth valuation model given in Equation 12.12, find the

market value of Tampa’s equity under each of the three capital structures at

the $1,200,000 level of expected EBIT.

e. On the basis of your findings in parts cand d,which capital structure would

you recommend? Why?

WEB EXERCISE Go to the Web sitewww.smartmoney.com. In the column on the right under
Quotes & Researchenter the symbolDIS; click on Stock Snapshot; and then
click onGo.

1. What is the name of the company? Click on Financials.


2. What are the 5-year high and the 5-year low for the company’s debt/equity
   ratio (the ratio of long-term debt to stockholders’ equity)?

At the bottom of this page under Stock Search, enter the next stock symbol from

the list below and then click on Submit. Enter the name of the company in the

matrix below and then click on Financials. Enter the 5-year high and low for the

debt/equity ratio in the matrix for each of the stock symbols.

Debt/equity ratio

Symbol Company name 5-yr. low 5-yr. high

DIS 

AIT 

MRK 

LG 

LUV 

IBM 

GE 

BUD 

PFE 

INTC