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

Question

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

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% $3.10         $32.25            
            30 3.50         36.75            
            40 3.85         37.50            
            50 3.65         32.75            

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

? % debt
? % equity

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

? %

Answers

When stock price is maximum, capital structure is optimum. Here, capital structure is optimum at 40% debt to capital ratio as at that ratio, EPS and stock prices are highest.

Hence, Debt = 20% and Equity = 80%

WACC is minimized at 40% Debt/Capital Ratio.

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