Jackson Trucking Company is in the process of setting its target capital structu
ID: 2674617 • Letter: J
Question
Jackson Trucking Company is in the process of setting its target capital structure. The CFO believes the optimal debt ratio is somewhere between 20% and 50% , and her staff compiled the following projections for EPS and the stock price at various levels of debt:Debt 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
Assume that the firm uses only debt and common equity, What is Jackson's optimal capital structure? At what debt ratio is the company's WACC minimized?
Explanation / Answer
The optimal capital structure is the one that maximizes the stock price, and this will always be lower than the debt/equity ratio that maximizes expected EPS. With the above reasoning, the optimal capital structure is 30% which has projected stock price of $36.5 The optimal capital structure minimizes the WACC. Answer - debt ratio = 30%
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