Chapter 14
Capital Structure Management in Practice
12. Values in millions of dollars
a. VC = 0.4($30) = $12
b. Interest = [(0.1 x $2) + (0.12 x $10)] = $1.4
d. Current EPS:
EBIT $8.00
3.6 = %EPS/-5%
13. Values in millions of dollars
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Chapter 14
Capital Structure Management in Practice
a. VC = 0.65 ($40) = $26
b. Interest expenses = (0.10 x $10) + (0.12 x $3) = $1.36
c. DCL = DOL x DFL = 3.69
Current EPS:
EBIT $9.000
Interest 1.360
Note: The use of the average tax rate in this solution assumes that
this average rate does not change with a change in sales and EBIT.
14. DCL = DOL x DFL
8.0 = 2.0 x DFL
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Chapter 14
Capital Structure Management in Practice
15. DOL = 2.5 = %EBIT/+5%
%EBIT = +12.5%
16. The probability that EPS will be less than $5 per share is equal to
the
probability that sales will be less than $10,000,000:
17. Fixed =nancial charges to cover:
The probability of negative EPS is the probability of not covering =xed
financial charges, or:
18. a. Emco Products
EPS (debt =nancing) = EPS (equity =nancing)
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Chapter 14
Capital Structure Management in Practice
(EBIT – interest)(1 – tax rate) = (EBIT)(1 – tax rate)
(No. of common shares for debt (No. of common shares for equity
alternative) alternative)
[(EBIT – 5)(0.6)]/10 = [(EBIT)(0.6)]/15
b. Equity Financing:
EBIT = $10 EBIT = $15 EBIT = $25
EBIT $10 $15 $25
I 0 0 0
Debt Financing:
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Chapter 14
Capital Structure Management in Practice
EBIT = $10 EBIT = $15 EBIT = $25
EBIT $10 $15 $25
I 5 5 5
IndiDerence point = $15 million
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Chapter 14
Capital Structure Management in Practice
19.a. Expansion:
Rock Island Davenport
EBIT $100 $100
I 32 8
Recession:
Rock Island Davenport
EBIT $ 60 $ 60
I 32 8
b. Rock Island is riskier because of its financial risk. The two
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Chapter 14
Capital Structure Management in Practice
c. EPS (Rock Island) = EPS (Davenport)
[(EBIT – interest)(1 – T)]/No. of C.S. (Rock Island) =
[(EBIT – interest)(1 – T)]/No. of C.S. (Davenport)
d. Price = (EPS)(P/E ratio)
Rock Island:
Davenport:
This example gives approximately equal stock prices for the two companies.
Rock Island’s higher EPS is oDset by its lower P/E ratio.
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