A1. Capital Structure
Capital structure refers to how a company finances its operations. In general, this financing comes from two sources: debt and equity. In this case, Competition Bikes needs to finance its expansion and is considering five capital structure alternatives, which include various combinations of bonds and stock. To determine which capital structure provides the greatest return for shareholders, the metric used for comparing the different capital structures will be earnings per share (EPS). The following table shows the projected earnings per common stock share for each year, and for each alternative capital structure, based on a moderate forecast for Canadian Biking’s earnings before interest and taxes (EBIT). The highest earnings per share for each year are highlighted in yellow.
Capital Structure Alternatives :
12% bonds 50% preferred stock 50% common stock 20% - 12% bonds 80% common stock 40% - 12% bonds 60% common stock 60% - 12% bonds 40% common stock
Year 9 0.002 0.027 0.027 0.023 0.017 Year 10 0.009 0.032 0.032 0.028 0.023 Year 11 0.019 0.039 0.038 0.035 0.031 Year 12 0.031 0.048 0.046 0.043 0.040 Year 13 0.042 0.057 0.054 0.052 0.049 Earnings per share
JET2 TASK 3 3
The recommendation is to use the capital structure of 50% preferred and 50% common stock. Because there is no interest to be paid, all of the money raised can be kept within the company. Looking at the table above, it is easy to see that this structure will consistently provide Competition Bikes with greater earnings per