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Tobang Company is in the process of setting its target capital structure. The CFO believes the optimal debt ratio is somewhere between 20 and 50 percent, and her staff has compiled the following projections for EPS and the stock price at various debt levels:
Debt Ratio Projected EPS Projected Stock Price
20% $3.20 $35.00
30% $3.45 $36.50
40% $3.75 $36.25
50% $3.50 $36.00
a. Assuming that the firm uses only debt and common equity, what is Tobang's optimal capital structure?
b. At what debt-to-capital ratio is the company's WACC minimized?

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Answer:

The Ideal Capital structure is approximately 20% of Debt and 50% of Equity. Thus, Optimal Capital Structure of Tobang Company is 40:60.

At 40% debt ratio the company’s Weighted Average Cost of Capital (WACC) is minimized.

Explanation:

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