Middle East Cooling Systems, Inc., has total assets of US$10,000,000, EBIT of US$2,000,000, and preferred dividends of

Question:

Middle East Cooling Systems, Inc., has total assets of US$10,000,000, EBIT of US$2,000,000, and preferred dividends of US$200,000 and is taxed at a rate of 40 percent. 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 structureCost of debt, rdNo. of common

Debt ratiostock sharesRequired return, rs

0%.........................................0%.........................200,000.................................12%

15...................................8....................170,000....................................13

30...................................9...................140,000....................................14

45.................................12...................110,000....................................16

60.................................15.....................80,000....................................20

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

b. Use Equation 12.12 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.

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...