25300 Chapter 13 & 18: Capital Structure
Tutorial questions 25300 FBF
Tutorial 10 – Capital Structure
1. An unlevered firm is considering going into debt. The firm currently has 280,000 shares outstanding
valued at $25 each. The firm is planning to borrow $2 million and use the capital to repurchase
equity. The debt has an interest rate of 5% p.a. and the company tax rate is 30%.
(a) How many shares will be outstanding if the proposal proceeds?
(b) Should the firm proceed with the proposal if EBIT is predicted to be $350,000?
(c) What is the breakeven EBIT level?
2. Cross City Tunnel (CCT) Ltd currently has 5 million shares on issue each with a market price of $2.50.
CCT also has $3 million of debt. The Chief Financial Offer is considering changing the capital structure
by issuing $4 million of debt and using the entire proceeds to conduct a share buyback. The interest
rate on debt is 10% p.a. and the company tax rate is 30%.
(a) Calculate EPS for both the current and the proposed capital structures at a projected EBIT level
of $3.7 million. Which capital structure is preferable if this is the expected level of EBIT?
(b) At what level of EBIT is CCT indifferent between the two capital structures under consideration?
(c) Graph the current and proposed capital structures.
3. What are the limitations of using the breakeven EPS method to evaluate competing capital
structures?
(Answers: 1. (a) 200,000 (b) The firm is indifferent (c) $350,000, 2. (a) Current = $0.476, Proposed = $0.617, (b)
$1,550,000, 3. See lecture notes.)
Document Summary
An unlevered firm is considering going into debt. The firm currently has 280,000 shares outstanding valued at each. The firm is planning to borrow million and use the capital to repurchase equity. Cross city tunnel (cct) ltd currently has 5 million shares on issue each with a market price of . 50. The chief financial offer is considering changing the capital structure by issuing million of debt and using the entire proceeds to conduct a share buyback. The interest rate on debt is 10% p. a. and the company tax rate is 30%. (a) calculate eps for both the current and the proposed capital structures at a projected ebit level of . 7 million. Which capital structure is preferable if this is the expected level of ebit? (b) at what level of ebit is cct indifferent between the two capital structures under consideration? (c) graph the current and proposed capital structures.
