Integrativelong dashOptimal

capital structureMedallion Cooling Systems, has total assets of

$10,400,000,

EBIT of

$1,960,000,

and preferred dividends of

$202,000

and is taxed at a rate of

40%.

In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:

Capital structure debt ratio	Cost of debt, r Subscript drd	Number of common stock shares	Required return, r Subscript srs
0%	0%	202,000	11.9%
1515	8.18.1	175,000	13.1
3030	8.9	138,000	13.8
4545	12.1	113,000	16.2
6060	14.9	75,000	19.9

a. Calculate earnings per share for each level of indebtedness.

b. Use the equation

Upper P 0 equals EPS divided by r Subscript sP0=EPS/rs

and the earnings per share calculated in part

(a)

to calculate a price per share for each level of indebtedness.

c. Choose the optimal capital structure. Justify your choice.