JTC is in the process of setting its target capital structure. The CFO believes that the option debt-to-capital ratio is somewhere between 30% and 70%. The JTC staff has compiled the following projections for EPS and the WACC at various debt levels. Assuming that the firm used only debt and common equity, what is JTCs optimal capital structure?

Debt/Capital Ratio Projected EPS WACC

30% $1.10 8%

40% $1.20 7%

50% $1.25 8.5%

60% $1.20 9%

70% $1.15 9.5%

a. 60%

b. 40%

c. 50%

d. 70%

2. Firms Haley and Laura are identical except for their financial leverage ratios and interest rates they pay on debt. Each has $10 million in invested capital, has $4 million in EBIT, and is in the 50% federal-plus-state tax bracket. Haley, however, has a debt-to-capital ratio of 60% and pays 10% interest on its debt, whereas Laura has a 40% debt-to-capital ratio and pays 5% on its debt. Neither firm uses preferred stock in its capital structure. What is the ROE for each firm?

a. The ROE for Haley is 42.5% and the ROE for Laura is 31.7%

b. The ROE for Haley is 24.5% and the ROE for Laura is 26.7%

c. The ROE is 40% for each firm

d. The ROE is 20% for each firm