Norton Electrical has quite a few positive NPV projects from which to choose. Th

Question

Norton Electrical has quite a few positive NPV projects from which to choose. The problem is that it has more of these projects than it can finance without issuing new stock and the board of directors refuses to issue any new shares in the fore cable future. Norton's projected net income net $150.0 million. Its target capital structure is 25% debt and 75% equity, and its tangent payout ratio is 65%. the CFO now wants to determine how the maximum capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy. Versus the current policy, how much larger could the capital budget be if (1) the target debt ratio were raised to 75% other things held constant, and (3) the debt ratio and payout were both changed by the indicated amounts. (2) LeCompte Learning solution is considering making a change to its capital structure in hopes of increasing its value. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt. the company has produced the following table: The company uses the CAPM to estimate its costs of common equity, r_g The risk free rate is 2% and the market risk premium is 8% LeCompte estimate that if it had no debt its beta would be 1.0. (its "unlevered beta" b_u, equals 1.0) The company's tax rate. T. is 40% On the basis of this information, What is LeCompte's optimal capital structure, and what is the firm's cost of capital at his optimal capital structure? Please define optimal capital structure, why is it important to know for a firm?

Explanation / Answer

e. $140.0 $90.0 $410.0

as we have retained income $120 mln, 75% debt and 25% equity
capital budget = $120 mln / 0.25 = $480 mln,
the increase is $480 - $70 = $410 mln

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