The \"preceding points\" are shown BELOW d. With the preceding points in mind, n

Question

The "preceding points" are shown BELOW

d. With the preceding points in mind, now consider the optimal capital structure for SDSS. (1) To begin, define the term optimal capital structure (2) Describe briefly, without using numbers, the sequence of events that would occur if SDSS decided to change its capital structure to include more debt. Assume that shares could be repurchased at the current market price of $20 per share. Calculate SDSS's expected EPS and TIE at debt levels of $0, $250,000, $500,000, $750,000, and $1,000,000. How many shares would remain after recapitalization under each scenario? EPS = (Net income outstanding shares] (3) (4) What would be the new stock price if SDSS recapitalizes with $250,000 of debt? $500,000 (5) (6) (7) $750,000? $1,000,000? Recall that the SDSS pays out all earnings as dividends, sog 0 Considering only the levels of debt discussed, what is SDSS's optimal capital structure? Is EPS maximized at the debt level that maximizes share price? Why? What is the WACC at the optimal capital structure?

Explanation / Answer

1. Optimal capital structure is a combination of debt and equity capital financing which will minimize the firm's cost of capital which in turn will maximise its value.

2. SDSS will benefit if debt is included in the capital structure. Including more debt into the company will provide tax shield which will occur due to the use of debt financing. Because of this, the overall WACC reduces which in turn reduces the overall cost of capital of the comapny. This will be lower than cost of equity to the company.

3.

4.

Debt level Shares repurchased EBIT Interest EBT Tax Net Income No. of shares EPS TIE             -                        -   500,000          -      200,000      100,000 2     250,000                12,500 500,000    25,000 475,000 190,000    285,000        87,500 3.257142857 20     500,000                25,000 500,000    55,000 445,000 178,000    267,000        75,000 3.56 9.090909091     750,000                37,500 500,000    97,500 402,500 161,000    241,500        62,500 3.864 5.128205128 1,000,000                50,000 500,000 160,000 340,000 136,000    204,000        50,000 4.08 3.125

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