CALCULATING THE OPTIMUM DEBT-TO-EQUITY RATIO Your task is to determine which of the seven scenarios,...

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CALCULATING THE OPTIMUM DEBT-TO-EQUITY RATIO
Your task is to determine which of the seven scenarios, above, is the best (optimal) debtto-equity ratio for Napoli Pizza. You will want to use the information and formulas which Eva Perez has accumulated for you. When you work through the following steps, you will see that this is a relatively straight-forward process. Now, sit down with your favorite pizza (anchovies and onions) and set out to determine the capital structure that will maximize Napoli’s stock value.

optimal-capital-structure-napoli-pizza-5vtnxo1p.pdf

Ashok · Accepted Answer

Expected EBIT per year = $500,000
Shares outstanding = 100,000
Tax rate = 40%
ΒL = βu[1+(D/E)(1-T)]
a. 
	Scenario
	1
	2
	3
	4
	5
	6
	7
	Amount borrowed
	$0
	$200
	$400
	$600
	$800
	$1,000
	$1,200
	Equity after dividend
	$2,000
	$1,800
	$1,600
	$1,400
	$1,200
	$1,000
	$800
b. 
	Scenario
	1
	2
	3
	4
	5
	6
	7
	Debt/Equity(%)
	0%
	11%
	25%
	43%
	67%
	100%
	150%
c. 
	Scenario
	1
	2
	3
	4
	5
	6
	7
	Weight of Debt
	0%
	10%
	20%
	30%
	40%
	50%
	60%
	Weight of Equity
	100%
	90%
	80%
	70%
	60%
	50%
	40%
d. Cost of debt = (Treasury bond rate + risk premium)*(1-tax rate)
Treasury bond rate = 4.5%, Risk Premium = 7%, tax rate = 40%
	Scenario
	1
	2
	3
	4
	5
	6
	7
	After tax interest rate
	3.09%
	3.09%
	3.75%
	4.35%
	5.10%
	5.70%
	6.30%
e.

CALCULATING THE OPTIMUM DEBT-TO-EQUITY RATIO Your task is to determine which of the seven scenarios, above, is the best (optimal) debtto-equity ratio for Napoli Pizza. You will want to use the...

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