Question

Terrell Trucking Company is in the process of setting its target capital structure. The CFO believes that the optimal debt-to-capital ratio is somewhere between 20% and 50%, and her staff has compiled the following projections for EPS and the stock price at various debt levels:

Debt/Capital Ratio	Projected EPS	Projected Stock Price
20%	$3.15	$33.25
30	3.45	36.50
40	3.70	35.50
50	3.65	33.50

Assuming that the firm uses only debt and common equity, what is Terrell's optimal capital structure? Choose from the options provided above. Round your answers to two decimal places.

  % debt
  % equity

At what debt-to-capital ratio is the company's WACC minimized? Choose from the options provided above. Round your answer to two decimal places.

  %

Answer 1

Answer : Given the data of projected outcomes of EPS and Stock Price , the stock price is maximized at a level of $36.50 in which debt-to-capital ratio is of 30% and projected EPS of $3.45. The optimal capital structure is that capital structure which maximizes the firm’s stock price, and where the WACC is minimized. This often differs from the Capital structure ( which is 40 % debt and 60 % equity) which maximizes the firm’s projected EPS. Thus, the optimal capital structure is 30% debt and 70% (100 – 30 %) common equity, and this will also be the capital structure mix that minimizes the firm’s WACC . Therefore, capital structure (30% debt and 70% common equity) is also the Capital structure which minimizes company's WACC.