P12–26 Integrative: Optimal capital structure The board of directors of Morales Publishing, 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 a rate of 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 parts a and

b, calculate the most likely earnings per share for the firm at various levels of indebtedness. Mark the level of indebtedness that maximizes EPS.

d. Using the EPS developed in part

c, the estimates of required return, rs, and Equation 12.12, estimate the value per share at various levels of indebtedness. Mark the level of indebtedness in the following table that results in the maximum price per share, P0.

e. Prepare a recommendation to the board of directors of Morales Publishing that specifies the degree of indebtedness that will accomplish the firm’s goal of optimizing shareholder wealth. Use your findings in parts a through d to justify your recommendation.

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% Debt Total assets $ Debt $40,000,000 S 0% 10 40,000,000 20 40,000,000 30 40,000,000 40 40,000,000 50 40,000,000 60 40,000,000 $ Equity Number of shares @ $25 |||