Scenario: You are an analyst and have been assigned with the task of finding the optimal capital...

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Scenario: You are an analyst and have been assigned with the task of finding the optimal capital structure for your firm. Currently the firm is all equity, but the owner would like to cash out some equity and increase the amount of debt to a "safe" level. Thus, the shares will be repurchased by the majority stock holder at the price listed in the spreadsheet. The company is privately held so there will be no fluctuation in the stock price based on supply and demand.Please open and download the following spreadsheet,Target Capital Structure Student.xls			download.	You are required to recommend the number of shares that will optimize the value of the firm.	Please use the following spreadsheet for additional information and to show your analysis.	Submit your document to this drop box.Sheet1 	Repurchasing Shares to Change Capital Structure 	This is an example of a firm with 100% equity, A = E.  Firm currently has 100,000 shares of 	common stock outstanding, with a price of $20.  The EBIT for the firm will be $500,000.  The 	marginal tax rate for the firm is 40%.  All earnings are paid out in the form of dividends. 	Therefore, there is no growth for the firm and the stock price is determined by DPS/ks. 	The firm must borrow in increments of $250,000, with a maximum debt level of $1,000,000. 	The increases to the cost of debt and the cost of equity increases with debt is as follows: 				Amount Borrowed	kd	ks 				$   - 0	-	15.0% 				$   250,000	10.0%	15.5% 				$   500,000	11.0%	16.5% 				$   750,000	13.0%	18.0% 				$   1,000,000	16.0%	20.0% 	Sell bonds and repurchase common stock with proceeds. 		How many shares can we repurchase with issuing $250,000 of debt? 			$250,000 / $20	= 	With debt EBIT will now be reduced by interest expense and taxes will also be reduced. 		Number of Shares Repurchased =			12,500	25,000	37,500	50,000 				EBIT 				Interest 				EBT 				Taxes @40% 				NI 		What is the New EPS?		EPS = 	The issuance of debt changes EPS and ks (the required rate of return for investors). 		What is the New price of stock? 				DPS = 				Stock Price 		What is the optimal capital structure? 		Debt Level	Shares Out	Book Equity	kd	DPS	ks	P0	WACC	D/E 		$   - 0	100,000	$   2,000,000	-	$   3.00	15.0%	$   20.00	15.0%	0.0 		$   250,000 		$   500,000 		$   750,000 		$   1,000,000 Sheet2 	 &A Page &P Sheet3 	 &A Page &P Sheet4 	 &A Page &P Sheet5 	 &A Page &P Sheet6 	 &A Page &P Sheet7 	 &A Page &P Sheet8 	 &A Page &P Sheet9 	 &A Page &P Sheet10 	 &A Page &P Sheet11 	 &A Page &P Sheet12 	 &A Page &P Sheet13 	 &A Page &P Sheet14 	 &A Page &P Sheet15 	 &A Page &P Sheet16 	 &A Page &P

Shakeel · Accepted Answer

Sheet1
	Repurchasing Shares to Change Capital Structure
	This is an example of a firm with 100% equity, A = E.  Firm currently has 100,000 shares of
	common stock outstanding, with a price of $20.  The EBIT for the firm will be $500,000.  The
	marginal tax rate for the firm is 40%.  All earnings are paid out in the form of dividends.
	Therefore, there is no growth for the firm and the stock price is determined by DPS/ks.
	The firm must borrow in increments of $250,000, with a maximum debt level of $1,000,000.
	The increases to the cost of debt and the cost of equity increases with debt is as follows:
				Amount Borrowed	kd	ks
				$   - 0	-	15.0%
				$   250,000	10.0%	15.5%
				$   500,000	11.0%	16.5%
				$   750,000	13.0%	18.0%
				$   1,000,000	16.

Scenario : You are an analyst and have been assigned with the task of finding the optimal capital structure for your firm. Currently the firm is all equity, but the owner would like to cash out some...

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