Matchmaker Cards (MC) has $30 million in assets and EBIT equal to $3.5 million. If MC's debt ratio (DfTA) is 60 percent, the interest it pays on its debt is 11 percent and there will be 400,000 shares of stock outstanding, whereas if the debt ratio is 30 percent, interest is 7 percent and outstanding shares will equal 600,000.MC's marginaltax rate is 40 percent. Calculate MC's EPS and ROE for each capital structure (ROE = Net income/Equity). Which capital structure is better?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Matchmaker Cards (MC) has $30 million in assets and EBIT equal to $3.5 million. If MC's debt ratio (DfTA) is 60 percent, the interest it pays on its debt is 11 percent and there will be 400,000 shares of stock outstanding, whereas if the debt ratio is 30 percent, interest is 7 percent and outstanding shares will equal 600,000.MC's marginaltax rate is 40 percent. Calculate MC's EPS and ROE for each capital structure (ROE = Net income/Equity). Which capital structure is better?
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