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.

%

Debt/Capital Ratio Projected EPS Projected Stock Price             20% $3.15         $35.00                         30 3.60         35.75                         40 3.70         37.00                         50 3.55         32.25            

Explanation / Answer

The optimal capital structure is the one at which the value of the firm is maximized, i.e. the highest Stock Price.

In this case at 40% debt and 60% equity ratio, we get the optimal structure at which price is maximized at $37.00

The value of firm is maximized when the WACC is minimized. Hence, debt to capital when WACC is minimized is 30%.

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