Please see if these answers would be correct Rosewood Fabrics and Taggart Securi

Question

Please see if these answers would be correct

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? Debt ratio = 30%; equity ratio = 70% Debt ratio = 50%; equity ratio = 50% Debt ratio = 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60% Debt ratio = 70%; equity ratio = 30% Taggart's CFO also has collected financial information regarding the firm's capital structure, shown in the following table. Debt Ratio Equity Ratio ra U WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure described above is Taggart's optimal capital structure? Debt ratio = 30%; equity ratio = 70% Debt ratio = 50%; equity ratio = 50% Debt ratio = 60%; equity ratio = 40% Debt ratio = 70%; equity ratio = 30% Debt ratio = 40%; equity ratio = 60% Would an increase in the corporate tax rate tend to encourage firms to increase or decrease their debt ratio? Increase Decrease

Explanation / Answer

PART 1 is wrong the answer is b debt 50% and equity 50%. You need to understand that an optimal capital structure is the one which maximises the value of the firm. In this case a 50-50 structure is resulting in the maximum stock price hence it is the answer

Part 2 is also wrong the answer again is b debt 50% and equity 50%. The optimal capital structure also leads to lowest WACC. This capital structure is leading to lowest WACC of 8.01%. Hence is correct.

Part 3 is correct , the answer is indeed a - increase...interest paid on debt is tax deductible. So if the tax rate increases the companies should increase the debt in their capital structure in order to take advantage of interest tax shield

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