(I ONLY NEED HELP WITH CALCULATING THE TABLE : #7 you will need to calculate the % debt and equity that will give Moore plumbing the optimal capital structure (lowest WACC) PLEASE SHOW WORK

Tom spent the first few months on the new job trying to get a better handle on the bigger picture and puzzled over the companys historical balance sheets, income statements and cash flow statements. One area that concerned him was the companys heavy reliance on equity financing. Moore Plumbing has a large line of credit and uses this and short-term debt to finance its temporary working capital requirements. However, it does not use any permanent debt capital. Other construction related retail and wholesale companies have between 30 and 40 percent of their long-term capitalization in debt. Tom wonders why other companies use more permanent debt and what affect adding long-term debt would have on the companys earnings and stock price.

Tom met with the companys vice president of finance, Walt Harriman, and learned that the company projected its earnings before interest and taxes to be $12 million for the next year with projected tax rate to be 40%. Tom next talked to the companys investment bankers and discovered that the companys cost of equity was 16%. Since the company did not use debt or preferred stock financing, this also represented the companys current weighted average cost of capital. The investment bankers indicated that the company could issue at least $30 million of long-term debt at a cost of 9%. The company bonds would be highly rated and would carry a low coupon because the company easily service the debt.

Because of Stans depression experience and his early involvement in funding the initial operation, the company not only avoided debt but also followed a policy of paying out most of its earnings as dividends, Stan was frequently quoted saying a company with a high dividend policy rarely declared bankruptcy. In lieu of using retained earnings to reinvest in the company, the company used accounts payable and deferred taxes to meet its operating capital needs and issued capital was purchased by members of the Moore family and they currently hold 75 %of the outstanding equity.

Tom is interested in gaining additional insights into capital structure issues and has asked Walt to brief him in the area. He wants a basic review of the terminology but is particularly interested in the impact of different types of risk and in understanding of the better-known financial theorists. Walt knew that Tom could grasp complex issues quickly and felt that a thorough discussion of Modigliani and Millers work would be appropriate. He also felt that Millers addition of personal taxes to the earlier models would be good to cover, and he determined that a good approximation of personal tax rate on debt income was 28% and for stock income was 20%. He decided to add the more recent considerations of financial distress, agency costs and information asymmetry for a comprehensive overview. To help with this analysis, Walt developed the following estimates for cost of debt and cost of equity that included an increasing premium for financial distress and agency costs as the debt ratio increases.

Debt ratio kd ks

__________________________________________

0% ---- 16.0%

10% 9.00% 17.0%

20% 9.25% 17.8%

30% 9.75% 19.0%

40% 10.50% 20.5%

50% 12.00% 22.0%

60% 15.00% 26.0%

70% 20.00% 30.0%

80% 30.00% 40.0%

90% 50.00% 60.0%

You have been assigned to help Walt develop the briefing and he has prepared the following questions to help direct your energies. He has also asked you to think about other relevant issues that Moore might bring up. Walt is aware of Toms keen intellect but is also aware of his reputation for asking the right questions and for having little tolerance for people who are not adequately prepared so he is concerned about covering the issues in an understandable manner.

Questions

What is meant by capitalization? What is meant by a firms capital structure? For financial planning purposes, explain why either book or market value should be used to determine the firms capital structure. What is capital structure theory?

Discuss the following issues relating to business risk and financial risk.

What is the difference between business risk and financial risk? Explain some of the factors that contribute to each. Evaluate Moore Plumbing Supplys level of business risk.

How do these risks relate to total risk?

How does business risk affect capital structure decisions?

Discuss the following issues relating to Modigliani and Millers (MM) 1958 capital structure model.

What was the importance of the model?

What are the basic assumptions of the model?

Discuss MMs later models (1963) in which they relaxed the no-tax assumption and added corporate taxes. Discuss Proposition I and II. Miller added personal taxes to the model in his 1976 Presidential Address to the American Finance Association. What happens to Millers model, in general, if there are no corporate or personal taxes? What happens when only corporate taxes exist?

Briefly describe the asymmetric information theory of capital structure. What are its implications for financial managers?

Prepare a summary of the implications of capital structure theory that can be presented to Tom Moore. What insights can capital structure theory provide managers regarding the factors which influence their firms optimal capital structures?

Finally, what recommendations would you make about the capital structure of Moore Plumbing Supply Company? Justify your answer.

Once completed, submit your Assignment to the Assignment Dropbox.

The Module 4 Competency Assessment has three parts.

Part 1 Capital Structure

Describe what is meant by capitalization

Explain book and market value related to determine capital structure

Part 2 Issues related to business and financial risk

Discuss the differences between business risk and financial risk

Explain factors that contribute to each

Part 3 Summary of implications of Capital Structure Theory

Discuss MM capital structure model

Describe asymmetric information theory of capital structure

Prepare a summary of the implications of capital structure theory