IntegrativeOptimal capital structure Nelson Corporation has made the following forecast ofsales, with the associated probabilities of occurrence noted(table to theright).

The company has fixed operating costs of $98,000 peryear, and variable operating costs represent 40% of sales. The existing capital structure consists of 25,000 shares of common stock that have a $11 per share book value. No other capital items are outstanding. The marketplace has assigned the following required returns to risky earnings per share(table to theright).

The company is contemplating shifting its capital structure by substituting debt in the capital structure for common stock. The three different debt ratios under consideration are shown in the table to theright, along with anestimate, for eachratio, of the corresponding required interest rate on all debt.

The tax rate is 40%. The market value of the equity for a leveraged firm can be found by using the simplified method (P0=EPS/rs).

a. Calculate the expected earnings per share(EPS), the standard deviation ofEPS, and the coefficient of variation of EPS for the three proposed capital structures.

b. Determine the optimal capitalstructure, assuming(1) maximization of earnings per share and(2) maximization of share value.

c. Construct a graph showing the relationships in part (b). (Note: You will probably have to sketch thelines, because you have only three datapoints.)

Sales Probability $204.000 0.20 304,000 0.60 404.000 0.20