Optimal capital structure Cosmetic Manufacturers is contemplating changing the capital structure of the firm. The firm has $45,000,000 in total assets, earnings before interest and taxes of $8,500,000, and is taxed at a rate of 40%. a. Complete the following table showing the values of debt, equity, and the total number of shares of common stock. The book value is $20 per share.

% Debt Total assets Debt ($) Equity ($) Number of shares @ $20 0% $45,000,000 $ _______ $ _______ _______

10 45,000,000 _______ _______ _______

20 45,000,000 _______ _______ _______

30 45,000,000 _______ _______ _______

40 45,000,000 _______ _______ _______

50 45,000,000 _______ _______ _______

60 45,000,000 _______ _______ _______

b. Complete the following table indicating the total debt and interest expense for each level of indebtedness.

% Debt Total debt ($) Before-tax cost of debt, rd Interest expense ($)

0% $ _______ 0.0% $ _______

10 _______ 7.0 _______

20 _______ 8.0 _______

30 _______ 9.5 _______

40 _______ 11.0 _______

50 _______ 12.5 _______

60 _______ 15.5 _______

c. Using an EBIT of $7,500,000, a 40% tax rate, and the information developed in parts a and b, calculate the most likely earnings per share (EPS) for the firm at each level of indebtedness.

% Debt EBIT Interest expense EBT Taxes Net income Number of shares EPS 0% $7,500,000 $ _______ $ _______ $ _______ $ _______ _______ $ _______

10 7,500,000 _______ _______ _______ _______ _______ _______

20 7,500,000 _______ _______ _______ _______ _______ _______

30 7,500,000 _______ _______ _______ _______ _______ _______

40 7,500,000 _______ _______ _______ _______ _______ _______

50 7,500,000 _______ _______ _______ _______ _______ _______

60 7,500,000 _______ _______ _______ _______ _______ _______

d. Complete the following table showing the estimates of the value per share at various levels of indebtedness. The estimates of required return are denoted by rs .

% Debt EPS rs P0

0% $ _______ 10.0% $ _______

10% _______ 10.3% _______

20% _______ 10.9% _______

30% _______ 11.4% _______

40% _______ 12.6% _______

50% _______ 14.8% _______

60% _______ 17.5% _______

e. Based on your answer in the previous parts, which debt ratio would you recommend? Explain your answer.