4.Based on the information below, what is the firm\'s optimal capital structure?

Question

4.Based on the information below, what is the firm's optimal capital structure?
Answer
a. Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
b. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
c. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
d. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
e. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.


5.Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?
Answer
a. A decrease in costs incurred when filing for bankruptcy.
b. The Federal Reserve tightens interest rates in an effort to fight inflation.
c. Statements a and b are correct.
d. An increase in the personal tax rate.
e. An increase in the company's operating leverage.

Explanation / Answer

4.option "B" is the correct answer. since the cost of equity is very low at option "B" among all.. 3.31/ 30 = 10.19% 5.option " d'" is the correct answer. Through cahnging in operating leverage , EBIT will be increased.So that if he increase target debt ,then he will deduct First interest from the EBIT ,Then ,He will pay Tax on the reamin amont. So here Tax burden will be reduce.

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