XYZ inc. is setting its target capital structure. The CFO of XYZ Inc. believes t

Question

XYZ inc. is setting its target capital structure. The CFO of XYZ Inc. believes that the optimal debt-to-capital ratio is between 25 percent and 60 percent. Her staff derived following the projections. Various debt levels were considered.

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

Debt/Capital Ratio Projected EPS Projected Stock Price Dept/Capital Ratio Projected EPS Projected Stock Price 25% $4.20 $40.00 35% $4.45 $41.50 45% $4.75 $41.25 60% $4.50 $40.59

Explanation / Answer

Answer:

Optimal capital structure means the debt to capital ratio at which the firms value is maximum or say the firm has the maximum market capitalization.

So the optimal capital structure shall be at which the firm has highest market price that is 35%

WACC is minimum at optimal capital structure, hence the answer remains same 35%

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