Capital Structure Case Essay

1161 Words5 Pages
Team D

Hi everyone, 

Here is our week 4 assignment. I highlighted how I propose we split up this assignment. Each section should be about 150 - 200 words. 


Resource: Evaluating McGraw Industries’ Capital Structure Case in Ch. 11 of Principles of Managerial Finance
Write a 350- to 700-word memo to the president of McGraw Industries that responds to questions in the case.
Explain how the cost of debt, cost of equity, and weighted average cost of capital are determined.
Cost of debt is simply the weighted rates of interest paid by the company on its debts. However, cost is equity is not so straightforward. The cost of equity is based on an estimate of a reasonable rate of return on the shareholders' investment. The term ‘reasonable’
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However, even though earnings per share will be maximized with this capital structure, it may not be the best option. With the increased debt, the company will be considered a financial risk with a low times interest earned ratio of 2.00. A low times interest earned ratio indicates that the company may be unable to make payments on contractual interest that becomes due and this is a great risk factor.

d. Using the zero-growth valuation model given in Equation 11.12, find the market value of McGraw’s equity under each of the three capital structures at the $1,200,000 level of expected EBIT.
Current Capital Structure: so, $6.12 / .12 = 55.5 or $55.50
Alternative A at 30%: so, $7.71 / .13 = 59.31 or $59.31
Alternative B at 50%: so, $9.00 / .18 = 50.00 or $50.00

e. On the basis of your findings in parts c and d, which capital structure would you recommend? Why?
After evaluating which structure can maximize EPS and keep EPS high during zero growth valuation, I believe alternative A is the best. The reason alternative A is better then both the current structure and alternative B is it raise EPS and still keeps debt at a low percentage. This allows the company to have more financial leverage, not be a risk for falling behind at a time interest ratio of 4.00, and give a decent return to shareholders. The current option is too much equity financing with a smaller EPS and
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