Bigtech Inc. is looking at how to best to improve its capital structure and has
ID: 2804826 • Letter: B
Question
Bigtech Inc. is looking at how to best to improve its capital structure and has estimated the
costs of debt and equity capital for various proportions of debt in its capital structure
% of Debt
Cost of Debt
Cost of Equity
35
5.4%
13.8%
40
5.6
14.0
45
5.9
14.3
50
6.4
14.7
If Bigtech pays a current dividend of $1.50 and expects dividends to grow at a constant rate of 7%, what is the stock price if it obtains its optimal capital structure? What does this mean for the company?
% of Debt
Cost of Debt
Cost of Equity
35
5.4%
13.8%
40
5.6
14.0
45
5.9
14.3
50
6.4
14.7
Explanation / Answer
optimal capital structure is one which has low cost of capital
hence
cost of capital = 10.52%
price = dividend next year /(cost of equity- growth rate)
=1.5 * 1.07/14.3% -7%
= 12.07
% of Debt Cost of Debt Cost of Equity cost of capital 35% 5.40% 13.80% 10.86% 40% 5.60% 14% 10.64% 45% 5.90% 14.30% 10.52% 50% 6.40% 14.70% 10.55%Related Questions
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