CFIN6
Chapter 11 Spreadsheet Problem
Cost of Capital
Use the model in the File C11 to work this problem.
Ezzell Enterprises has the following capital structure, which it considers to be optimal under present and
forecasted conditions:
Debt (long-term only) 45%
For the coming year, management expects after-tax earnings of $2.5 million. Ezzell’s past dividend
policy of paying out 60 percent of earnings will continue. Present commitments from its banker will
allow Ezzell to borrow according to the following schedule:
Loan Amount Interest Rate
The company’s marginal tax rate is 40 percent, the current market price of its stock is $22 per share, its
last dividend was $2.20 per share, and the expected growth rate is 5 percent. External equity (new
common) can be sold at a flotation cost of 10 percent.
Ezzell has the following independent investment opportunities for the next year:
Project Cost IRR
1 $675,000 16.0%
CFIN6
Management asks you to help determine which projects (if any) should be undertaken. You proceed with
this analysis by answering the following questions (or performing the tasks) as posed in a logical
sequence:
a. How many breaks are there in the MCC schedule? At what dollar amounts do the breaks occur, and
what causes them?
e. The problem stated that Ezzell pays out 60 percent of its earnings as dividends. How would the
analysis change if the payout ratio were changed to zero, to 100 percent, or somewhere in between?
(No calculations are necessary.)
g. Assume the facts as in part f, but suppose Ezzell’s marginal tax rate falls (1) to 20 percent or (2) to 0
percent. How would this affect the MCC schedule and the optimal investment?