12-25 Question a, b, c

c. Choose oose the tne opt Bpemial apital structure. Justify your choice ative: Optimal capital structure Nelson Law Partners has made the following 12-25 Integrative: orecast of sales, with the associated probabilities of occurrence noted. Sales $200,000 300,000 400,000 Probability 0.20 0.60 0.20 The company has fixed operating costs of $100,000 per year, and variable operating costs represent 40% of sales. The existing capital structure consists of 25,000 shares of com- mon stock that have a $10 per share book value. No other capital items are outstanding. The marketplace has assigned the following required returns to risky earnings per share. Coefficient of variation of EPS 0.43 0.47 0.51 0.56 0.60 0.64 Estimated required return, r, 15% 16 17 18 24 The company is contemplating shifting its capital structure by substituting debt Coefficient of variation of EPS 0,43 0.47 0.51 0,56 0,60 0.64 Estimated required return, r. 15% l6 17 18 24 The company is contemplating shifting its capital structure by substituting debt the capital structure for common stock. The three different debt ratios under con- eration are shown in the following table, along with an estimate, for each ratio, the corresponding required interest rate on all debt. Debt ratio 20% 40 60 Interest rate on all debt 10% 12 14 SX Long-7erm Financial Decisions equity for a leveraged firm rate is 40%. The market value of the Calculate the expected earnings per share (EPS), the standard dev can b The tax ound by sning the simplified method (see Equation 12.12). capita b. Determine the optimal capital structure, assuming (1) maximizstion of eam c. Construct a graph (similar to Figure 12.6) showing the relationships in part EPS, and the coeffient of variation of EPS for the three proposed per share and (2) maximization of share value. Note: You will probably have to sketch the lines because you have only th structures. data points.) 12-2 Intga ative: Optimal capital structure The board of directors of Morales Pub Inc. has commissioned a capital structure study. The company ha 540,0000. It has earnings before interest and taxes of $8,000 rate of 21 mpany has total asses 00 and s