Terrell Trucking Company is in the process of setting its target capital structu

Question

Terrell Trucking Company is in the process of setting its target capital structure. The CFO believes that 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 Terrell's optimal capital structure? Round your answers to two decimal places.

% debt
% equity

At what debt-to-capital ratio is the company's WACC minimized? Round your answer to two decimal places.

%

Terrell Trucking Company is in the process of setting its target capital structure. The CFO believes that 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:

Debt/Capital Ratio Projected EPS Projected Stock Price             20% $3.15         $34.75                         30 3.45         36.25                         40 3.85         37.75                         50 3.65         34.00            

Assuming that the firm uses only debt and common equity, what is Terrell's optimal capital structure? Round your answers to two decimal places.

% debt
% equity

At what debt-to-capital ratio is the company's WACC minimized? Round your answer to two decimal places.

%

Explanation / Answer

Answer a.

Optimal Capital Structure is that capital structure where stock price is maximized and WACC is minimized.
Maximum Stock Price is $37.75 in 40% debt ratio.

So, Optimal Capital Structure is 40% debt and 60% equity.

Answer b.

WACC is minimum under Optimal Capital Structure.

So, debt-to-capital ratio is 40% where WACC is minimum.

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