Optimal Capital Structure for a Manufacturing Firm

Optimal Capital Structure

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Question

Given the following information about a manufacturing firm, determine the optimal capital structure.

The optimal capital structure for this firm is:

Answers

A. 10% Debt, 90% Equity.

B. 25% Debt, 40% Equity.

C. 40% Debt, 60% Equity.

D. 50% Debt, 50% Equity.

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Explanations

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A. B. C. D.

After calculating the missing data points in the table, we can determine that the capital structure of 40% debt and 60% equity minimizes the WACC and maximizes the stock price (see calculations below), and is thus considered optimal.

To calculate WACC for the missing data points, we will use the formula:

WACC = (wd)(kd) + (we)(ke), where wd, weare the weights used for debt and common equity.

To calculate the Stock Price for the missing data points, we will use the formula:P0= D1/ ke

Here, we need to calculate D1using the EPS and payout information; g is given as 0.0%.

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