We can now estimate the value of Cooke Company’s stock under each of the alternative capital… 1 answer below »

We can now estimate the value of Cooke Company’s stock under each of the alternative capital structures. Substituting the expected EPS (column 1 of Table 12.13) and the required returns, ks (column 2 of Table 12.14), into Equation 12.12 for each of the capital structures, we obtain the share values given in column 3 of Table 12.15. Plotting the resulting share values against the associated debt ratios, as shown in Figure 12.7, clearly illustrates that the maximum share value occurs at the capital structure associated with a debt ratio of 30%.

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TABLE 12.15

Calculation of Share Value
Estimates Associated with
Alternative Capital Structures
for Cooke Company

Capital structure
debt ratio

Expected EPS
(from column 1
of Table 12.13)
(1)

Estimated
required return, ks
(from column 2
of Table 12.14)
(2)

Estimated
share value
[(1) ÷ (2)]
(3)

0%

$2.40

0.115

$20.87

10

2.55

0.117

21.79

20

2.72

0.121

22.48

30

2.91

0.125

23.28

40

3.12

0.14

22.29

50

3.18

0.165

19.27

60

3.03

0.19

15.95

 

TABLE 12.14

Required Returns for Cooke
Company’s Alternative
Capital Structures

Capital structure
debt ratio

Coefficient of
variation of EPS
(from column 3
of Table 12.13)
(1)

Estimated required
return, ks
(2)

0%

0.71

11.50%

10

0.74

11.7

20

0.78

12.1

30

0.83

12.5

40

0.91

14

50

1.07

16.5

60

1.4

19

 

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TABLE 12.13

Expected EPS, Standard Deviation, and
Coefficient of Variation for Alternative
Capital Structures for Cooke Company

Capital structure
debt ratio

Expected EPS
(1)

Standard deviation
of EPS
(2)

Coefficient of
variation of EPS
[(2) x (1)]
(3)

0%

$2.40

$1.70

0.71

10

2.55

1.88

0.74

20

2.72

2.13

0.78

30

2.91

2.42

0.83

40

3.12

2.83

0.91

50

3.18

3.39

1.07

60

3.03

4.24

1.4

 

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