Jackson Trucking Company is in the process of setting its target capital structu
ID: 2692330 • Letter: J
Question
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:
Assuming that the firm uses only debt and common equity, what is Jackson's optimal capital structure? (Round your answers to two decimal places.)
_______ % Debt
_______ % Equity
At what debt ratio is the company's WACC minimized? Round your answer to two decimal places.
_______ %
Debt/Capital Ratio Projected EPS Projected Stock Price 20% $3.05 $34.50 30 3.60 37.25 40 3.70 36.75 50 3.60 32.25Explanation / Answer
The optimal capital structure is that capital structure where WACC is minimized and stock price is maximized. Because Jackson’s stock price is maximized at a 30% debt ratio, the firm’s optimal capital structure is 30% debt and 70% equity. This is also the debt level where the firm’s WACC is minimized.
#3 Harley Motors has $10 million in assets, which were financed with $3 million in debt and $7 million in equity. Harely's beta is currently 1.4, and its tax rate is 35%. Use the Hamada equation to find Harley's unlevered beta
From the Hamada equation, b = bU[1 + (1 – T)(D/E)], we can calculate bU as bU = b/[1 + (1 – T)(D/E)].
bU = 1.4/[1 + (1 – 0.35)($3,000,000/$7,000,000)]
bU = 1.4/[1 + 0.278571]
bU = 1.095
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