Tangshan mining company must choose its optimal capital structure. Currently, the firm has 40 percent debt ratio and the firm expects to generate a common stock dividend of $4.89 per share next year. The firm's common stock dividends are expected to grow at a constant rate of 5 percent per year for the foreseeable future. Common stockholders currently require 10.89 percent annual return on their investments.
Tangshan mining is considering changing its capital structure, if such change would benefit the shareholders. The firm estimates that if it increases the debt ratio to 50 percent, it will increase the expected common stock dividend to $5.24 per share next year. Because of the additional leverage, common stock dividend growth is also expected to increase to 6 percent per year and this growth will be sustained indefinitely thereafter. However because of the added risk associated with a higher level of debt, the required rate of return demanded by common stockholders will increase to 11.34 percent per year.
Find Tangshan mining's share price under the current capital structure.
Find Tangshan mining’s share price under the proposed capital structure.
Given the answers from part a and part b, should Tangshan Mining change the firm’s capital structure? Explain