Nico Trading Company must choose its optimal capital structure. Currently, the f
ID: 2801882 • Letter: N
Question
Nico Trading Company must choose its optimal capital structure. Currently, the firm has a 20 percent debt ratio and the firm expects to generate a dividend next year of $5.44 per share. Dividends are expected to remain at this level indefinitely. Stockholders currently require a 12.1 percent return on their investment. Nico is considering changing its capital structure if it would benefit shareholders. The firm estimates that if it increases the debt ratio to 30 percent, it will increase its expected dividend to $5.82 per share. Again, dividends are expected to remain at this new level indefinitely. However, because of the added risk, the required return demanded by stockholders will increase to 12.6 percent. Based on this information, should Nico make the change?
Yes, because the stock price will increase from $44.96 to $46.19.
No, because the stock price will decrease from $27.20 to $19.40.
Yes, because the EPS will increase from $5.44 to $5.82.
Not enough information to answer the question.
Yes, because the stock price will increase from $44.96 to $46.19.
No, because the stock price will decrease from $27.20 to $19.40.
Yes, because the EPS will increase from $5.44 to $5.82.
Not enough information to answer the question.
Explanation / Answer
Stock price at current Capital structure = $5.44 / 12.10%
= $44.96
Stock price at current Capital structure is $44.96.
Again,
Stock price at new capital structure = $5.82 / 12.60%
= $46.19
Stock price at new capital structure is $46.19.
Since, stock price increase after change in capital structure. So, Nico Should make this change. because the stock price will increase from $44.96 to $46.19.
Option (A) is correct answer.
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