Harry Trading Company Must Choose Its Optimal Capital Structure

Multiple Choice

Harry Trading Company must choose its optimal capital structure. Currently, the firm has a 20 percent debt ratio and the firm expects to generate a dividend next year of $5.44 per share. Dividends are expected to remain at this level indefinitely. Stockholders currently require a 12.1 percent return on their investment. Harry is considering changing its capital structure if it would benefit shareholders. The firm estimates that if it increases the debt ratio to 30 percent, it will increase its expected dividend to $5.82 per share. Again, dividends are expected to remain at this new level indefinitely. However, because of the added risk, the required return demanded by stockholders will increase to 12.6 percent. Based on this information, should Harry make the change?

A) Yes, since the value of the firm will increase by $1.23 per share.
B) No, since the value of the firm will decrease by $1.23 per share.
C) Yes, since the value of the firm will increase by $0.25 per share.
D) No, since the value of the firm will decrease by $0.25 per share.