Investor-supplied funds.

The mix of debt, preferred stock, and

common equity that is used to finance the
firm’s assets.
Maximizes a stock’s intrinsic value.
WACC is minimized and stock price is
maximized.
Capital Structure is defined by debt ratio:
𝐷𝑒𝑏𝑡 𝐷𝑒𝑏𝑡
Debt Ratio = =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝐷𝑒𝑏𝑡+𝐸𝑞𝑢𝑖𝑡𝑦
𝐷𝑒𝑏𝑡
Debt-to-Equity ratio =
𝐸𝑞𝑢𝑖𝑡𝑦

For valuation Purposes, ‘debt’ excludes non-

investor supplied liabilities such as accruals
and payables
 Zippy Pasta Corporation (ZPC) has a constant growth rate of
7 percent. The company retains 30 percent of its earnings to
fund future growth. ZPC’s expected EPS (EPS1) and ks for
various capital structures are given below. What is the
optimal capital structure for ZPC?
Debt/Total Assets Expected EPS Ks

20% 2.50 15%

30 3.00 15.5
40 3.25 16
50 3.75 17
70 4.00 18
 Jackson 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/Capita Projected Projected
l Ratio EPS Stock Price
20.00% ₱ 3.20 ₱ 35.00
30.00% 3.45 36.50
40.00% 3.75 36.25
50.00% 3.50 35.50
Assuming that the firm uses only debt and common equity, what
is Jackson’s optimal capital structure? At what debt-to-capital
ratio is the company’s WACC minimized?
 Given the following choices, what is the optimal capital
structure for Chip Co.? (Assume that the company’s growth rate
is 2 percent) Dividends per Cost of
Debt Ratio Share Equity
0% ₱ 5.50 11.50%
25 6.00 12
40 6.50 13
50 7.00 14
75 7.50 15

a. 0% debt; 100% equity b. 25% debt; 75% equity

c. 40% debt; 60% equity d. 50% debt; 50% equity
e. 75% debt; 25% equity