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:

Debt/Capital Ratio Projected EPS Projected Stock Price

20% $3.20 $35.00

30 3.45 36.50

40 3.75 36.25

50 3.50 35.50

Assuming that the firm uses only debt and common equity, what is Jackson's optimal capital structure? At what debt-to-capital ratio is the company's WACC minimized?

Explanation / Answer

WACC and stock price has inverse relationship. If WACC decrease stock price will increases and vice-versa.

Hence, correct option is 30% debt/capital ratio

Because at this ratio stock price is maximum and WACC will be minimum.

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