Company C has total assets of $2,500,000, expected EBIT of $450,000 in perpetuit

Question

Company C has total assets of $2,500,000, expected EBIT of $450,000 in perpetuity and preferred dividends (also in perpetuity) of $45,000. The firm would like to determine its optimal capital structure. The tax rate is 35%. Based on the information below, provide your recommendation. Show all calculations and justify your recommendation.

capital structure debt ratio cost of debt number of common shares Ns Required returns Rs 0% 0.00 82,500 0.120 20% 0.05 75,000 0.121 40% 0.10 58,500 0.128 60% 0.15 32,100 0.135

Explanation / Answer

capital structure debt ratio

WACC is lowest for 40% debt ratio. so optimal debt ration is40% debt and 60% equity

capital structure debt ratio

cost of debt number of common shares Ns Required returns Rs After tax cost of debt WACC 0% 0 82,500 0.12 0 12.00% 20% 0.05 75,000 0.121 0.0325 10.33% 40% 0.1 58,500 0.128 0.065 10.28% 60% 0.15 32,100 0.135 0.0975 11.25%

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