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Tax rate0%
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Debt in the capital structure0%10%20%30%40%50%
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EBIT 120,000 120,000 120,000 120,000 120,000 120,000
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Interest - 4,125 8,750 14,625 22,000 31,250
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Profit before taxes 120,000 115,875 111,250 105,375 98,000 88,750
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Taxes - - - - - -
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Profit after taxes 120,000 115,875 111,250 105,375 98,000 88,750
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Dividends 120,000 115,875 111,250 105,375 98,000 88,750
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Total payments to security holders 120,000 120,000 120,000 120,000 120,000 120,000
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Required return on debt8.00%8.25%8.75%9.75%11.00%12.50%
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Required return on equity12.00%12.50%13.00%13.50%14.50%16.00%
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Market value of debt - 50,000 100,000 150,000 200,000 250,000
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Market value of equity 1,000,000 927,000 855,769 780,556 675,862 554,688
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Market value of the firm 1,000,000 977,000 955,769 930,556 875,862 804,688
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Book value of debt - 50,000 100,000 150,000 200,000 250,000
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Book value of equity 500,000 450,000 400,000 350,000 300,000 250,000
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Book value of the firm 500,000 500,000 500,000 500,000 500,000 500,000
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Return on total capital24.0%24.0%24.0%24.0%24.0%24.0%
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Return on equity24.0%25.8%27.8%30.1%32.7%35.5%
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Number of shares outstanding 5,000 4,744 4,477 4,194 3,858 3,447
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Price per share 200.0 195.4 191.2 186.1 175.2 160.9
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Earnings per share 24.00 24.43 24.85 25.13 25.40 25.75
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Price-earnings ratio 8.33 8.00 7.69 7.41 6.90 6.25
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Book value debt ratio0.0%10.0%20.0%30.0%40.0%50.0%
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Market value debt ratio0.0%5.1%10.5%16.1%22.8%31.1%
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Weighted average cost of capital12.0%12.3%12.6%12.9%13.7%14.9%
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Free cash flow 120,000 120,000 120,000 120,000 120,000 120,000
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Market value of the firm 1,000,000 977,000 955,769 930,556 875,862 804,688
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Note: The number of shares and price per share are computed from the following considerations.
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Assume the change from 0% debt to any other amount of debt is accomplished by repurchasing
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shares with the borrowed funds. Then the price per share times the number of shares repurchased
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must equal the amount borrowed. Also, the price per share times the number of shares remaining
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must equal the market value of equity. Together, these imply that the price per share times 5000
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must equal the market value of the firm. This fact is used to compute the price per share and then
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the number of shares is found by dividing the market value of equity by the price per share.
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