Stars truck Company would like to determine its optimal capital structure. Several of its managers believe that the best method is to rely on the estimated earrings per share (EPS) of the firm because they believe that profits and stock price are closely related. The financial managers have suggested another method that uses estimated required returns to estimate the share value of the firm. The following financial data are available.

Capital structure debt ratio Estimated EPSE estimated required return

TO DO
a. Based on the given financial data, create a spreadsheet to calculate the estimated share values associated with the seven alternative capital structures. Refer to Table 1.
TABLE 1 Calculation of Share Value Estimates Associated with Alternative Capital Structures for Cooke Company

Table 2 Expected EPS, Standard Deviaiton, and Coefficient of Variation for Alternative Captial Structures for Cooke Company

TABLE 3 Required Returns for Cooke Company? Alternative Capital Structures

b.Use Excel to graph the relationship between capital structure and the estimated EPS of the firm. What is the debt ratio? Refer to Figure.

c. Use Excel to graph the relationship between capital structure and the estimated share value of the firm. What is the optimal debt ratio? Refer to Figure.
d.Do both methods lead to the same optimal capital structure? Which method do you favor? Explain.
e.What is the major difference between the EPS and share value methods?

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$1.75 11.40% 0 10 1.90 43 3.18 3.06 3.10 12.50 13.25 18.00 19.00 25.00 Capltal structure Expected EPS (from column1 Estlmated requlred return, rs (from column 2 of Table 3) (2) 0.115 Estlmated share value [(1) debt ratlo 0% 10 20 30 40 50 60 of Table 2) (1) $2.40 2.55 2.72 2.91 3.12 3.18 3.03 0.121 0.125 0.140 0.165 0.190 $20.87 21.79 22.48 23.28 22.29 19.27 15.95 Standard deviation variat tion of EPS Expected EPS Capital structure debt ratio variation of EPS (from column 3 of Table 12.13) Estimated required return, r Capital structure debt ratio 090 10 20 30 40 50 60 0.71 0.74 0.78 0.83 0.91 1.07 1.40 11.5% 11.7 12.1 12.5 14.0 16.5 19.0 25.00 Maximum Share Value $23.28 20.00 Estimated Share Value 15.00 Maximum EPS $3.18 3.50 3.00 2.50 ш2.00 EPS 0 10 20 30 Maximum Share Value 40 50 Maximum EPS 60 70 Debt Ratio (%)