Unformatted text preview: al capital structure Nelson Corporation has made the following forecast of sales, with the associated probabilities of occurrence noted.
Sales Probability $200,000 .20 300,000 .60 400,000 .20 The company has fixed operating costs of $100,000 per year, and variable operating costs represent 40% of sales. The existing capital structure consists of
25,000 shares of common stock that have a $10 per share book value. No other
capital items are outstanding. The marketplace has assigned the following
required returns to risky earnings per share.
variation of EPS Estimated required
return, ks 0.43 15% 0.47 16 0.51 17 0.56 18 0.60 22 0.64 24 The company is contemplating shifting its capital structure by substituting debt
in the capital structure for common stock. The three different debt ratios under
consideration are shown in the following table, along with an estimate, for each
ratio, of the corresponding required interest rate on all debt.
ratio Interest rate
on all debt 20% 10% 40 12 60 14 The tax rate is 40%. The market value of the equity for a leveraged firm can be
found by using the simplified...
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