Tutorial 6

The German University in Cairo (GUC) Faculty of Management Technology Finance Department

Winter 2017 Dr. Mona Elbannan Corporate Finance

Tutorial 6

Chapter 13: Leverage and Capital Structure (Continued)

Problem One:

Medallion Cooling Systems, Inc., has total assets of $10,000,000, EBIT of $2,000,000, and  preferred dividends of $200,000 $200 ,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:

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

p art a to calculate a price per share for each level b. Use the earnings per share calculated in part of indebtedness. c. Choose the optimal capital structure. Justify your choice.

The German University in Cairo (GUC) Faculty of Management Technology Finance Department

Winter 2017 Dr. Mona Elbannan Corporate Finance

Problem Two

Tower Interiors has made the forecast of sales shown in the following table. Also given is the probability of each level of sales.

The firm has fixed operating costs of $75,000 and variable operating costs equal to 70% of the sales level. The company pays $12,000 in interest per period. The tax rate is 40%.

a. Compute the earnings before interest and taxes (EBIT) for each level of sales. b. Compute the earnings per share (EPS) for each level of sales, the expected EPS, assuming

that there are 10,000 shares of common stock outstanding. c. Tower has the opportunity to reduce its leverage to zero and pay no interest. This will

require that the number of shares outstanding be increased to 15,000. Repeat part b under this assumption. d. Compare your findings in parts b and c, and comment on the effect of the reduction of

debt to zero.