Nico Trading Company must choose its optimal capital structure. Currently, the f

Question

Nico Trading Company must choose its optimal capital structure. Currently, the firm has a 20 percent debt ratio and the firm expects to generate a dividend next year of $5.44 per share. Dividends are expected to remain at this level indefinitely. Stock- holders currently require a 12.1 percent return on their investment. Nico is consider- ing changing its capital structure if it would benefit shareholders. The firm estimates that if it increases the debt ratio to 30 percent, it will increase its expected dividend to $5.82 per share. Again, dividends are expected to remain at this new level indefi- nitely. However, because of the added risk, the required return demanded by stock holders will increase to 12.6 percent. Based on this information, should Nico make the change? a. Yes b. No c. It’s irrelevant d. Not enough information

Explanation / Answer

This information provides the data for stock dividend and exptected rate of return from stock, based on whicj we can calculate the expected share price after the change in capital structure.

But to get optimal capital structure we need to know the wighted average cost of capital by WACC method. For the WACC calculation the cost of debt , tax rate and are required to know the effect on WACC after the capital structure change .

So option d. not enough information is correct.

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