Rosewood Fabrics and Taggart Security Systems are two firms trying to identify t

Question

Rosewood Fabrics and Taggart Security Systems are two firms trying to identify their optimal capital structure. Rosewood's CFO has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio EPS DPS Stock Price 30% 70% 1.25 0.55 36.25 40% 60% 1.40 0.60 37.75 50% 50% 1.60 0.65 39.50 60% 40% 1.85 0.75 38.75 70% 30% 1.75 0.70 38.25 Which capital structure described above is Rosewood's optimal capital structure? a) Debt ratio = 50%; equity ratio = 50% b) Debt ratio = 40%; equity ratio = 60% c) Debt ratio = 70%; equity ratio = 30% d) Debt ratio = 60%; equity ratio = 40% e) Debt ratio = 30%; equity ratio = 70% Taggart's CFO also has collected financial information regarding the firm's capital structure, shown in the following table: Debt Ratio Equity Ratio rd rs WACC 30% 70% 7% 10.5% 8.61% 40% 60% 7.20% 10.8% 8.21% 50% 50% 7.70% 11.4% 8.01% 60% 40% 8.90% 12.2% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure described above is Taggart's optimal capital structure? a) Debt ratio = 50%; equity ratio = 50% b) Debt ratio = 40%; equity ratio = 60% c) Debt ratio = 70%; equity ratio = 30% d) Debt ratio = 60%; equity ratio = 40% e) Debt ratio = 30%; equity ratio = 70% Would an increase in corporate tax rate tend to encourage firms to increase or decrease their debt ratio? a) decrease b) increase Suppose reforms to the bankruptcy codes are expected to make bankruptcy less costly to firms. Is this likely to encourage firms to use more or less debt? a) more b) less

Explanation / Answer

1)a

2)b

3)e

4)d

5)a

6)c

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