The optimal capital structure of a company as suggested by its financial analyst is 60% equity and
Question:
The optimal capital structure of a company as suggested by its financial analyst is 60% equity and 40% debt. Since, all the earning of the company are paid out as dividends, therefore it does not have enough reserves in its retained earnings to fund the capital budget’s equity portion. This is why, the company issues new equity and incurs flotation costs which are adjusted against the cost of capital. You being the financial expert, are required to estimate the WACC of the company by using the data as under:
Growth = 0%.
Stock price (P0) = Rs.50.
Tax rate = 40%.
rd = 8% (before tax).
Retention ratio (RR) = 50%.
Net income (NI) = $80,000.
Shares outstanding = 20,000 (Total number).
Additional/new equity flotation cost = 15%.
Fundamentals of Financial Management
ISBN: 9780273713630
13th Revised edition
Authors: James van Horne, John Wachowicz