Optimal capital structure Jackson Trucking Company is in the process of setting

Question

Optimal capital structure

Jackson Trucking Company is in the process of setting its target capital structure. The CFO believes 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:

Assuming that the firm uses only debt and common equity, what is Jackson's optimal capital structure? Round your answers to two decimal places.

% debt
% equity

At what debt ratio is the company's WACC minimized? Round your answer to two decimal places.

%

Debt/Capital Ratio Projected EPS Projected Stock Price             20% $3.00         $33.50                         30 3.50         36.50                         40 3.90         37.50                         50 3.50         33.00            

Explanation / Answer

Answer: The optimal capital structure is that capital structure where WACC is minimized and stock price is maximized. Because Jackson’s stock price is maximized at a 40% debt ratio, the firm’s optimal capital structure is 40% debt and 60% equity. This is also the debt level where the firm’s WACC is minimized.

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