Optimal Capital Structure: Company A is setting its target capital structure. Th

Question

Optimal Capital Structure: Company A is setting its target capital structure. The CFO believes that the optimal debt-to-capital ratio is between 25% and 60%. The following projections are derived by the finance team. Various debt levels were considered.

Debt/Capital Ration Projected EPS Projected Stock Price

Assuming the company uses only debt and common equity, what is the optimal capital structure? At what debt-to-capital ratio is the company's WACC minimized? Please show calculations.

Dept/Capital Ratio Projected EPS Projected Stock Price 25% $4.20 $40.00 35% $4.45 $41.50 45% $4.75 $41.25 60% $4.50 $40.59

Explanation / Answer

at 45% of debt equity combination the EPS is $4.75 and the stock price is at $41.25 which is higher than any other cobination of debt and equity.

so, usually at this combination the firm carries less WACC and higher earnings.

at this combination the firm carries highest value in market and its EPS also higher than other combinations.

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