FINC1901 Corporate Finance

Tutorial 8_Capital Structure Exercise

Cosmetic Manufacturers is contemplating changing the capital structure of the firm.

The firm has $45 million in total assets, earnings before interest and taxes of $7.5
million and is taxed at a rate of 40%.
Complete the following tables showing:
a. The level of debt, equity and number of shares of common stock. The
nominal value is $20 per share
% Number of shares @
Total assets Debt ($) Equity ($)
Debt $20
$45,000,00
0%
0
$45,000,00
30%
0
$45,000,00
40%
0
$45,000,00
50%
0
$45,000,00
60%
0

b. The total debt and interest expense for each level of leverage
Note: the cost of debt before taxes (r d ¿ for each level of leverage is given
%
Total debt ($) Before-tax cost of debt, rd Interest expense ($)
Debt
0% 0.0%
30% 9.5%
40% 11.0%
50% 12.5%
60% 15.5%
c. The earnings per share (EPS) for each level of leverage
% Interest Net Number EP
EBIT EBT Taxes
Debt expense income of shares S
$7,500,00
0%
0
$7,500,00
30%
0
$7,500,00
40%
0
$7,500,00
50%
0
$7,500,00
60%
0
d. The estimates of the company share price for each level of leverage.
Note: the required rate of return (r s ¿ for each level of leverage is
given
%
EPS rs P0
Debt
0% 10.0%
30% 11.4%
 FINC1901 Corporate Finance
Tutorial 8_Capital Structure Exercise

40% 12.6%
50% 14.8%
60% 17.5%

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