Question

Corporation is privately owned and currently using only equity financing. The company's current market value is $2 billion, but management believes moving to an optimal financing mix would add $500 million in market value. If the optimal financing mix is determined to be 60% equity and 40% debt, how much total debt financing should Corporation use to reach its optimal financing mix?

Select one:

a.  $500 million

b.  $800 billion

c.  $1.2 billion

d. $1.5 billion

e. None of the above

Answer 1

The Optimal Mix is specified to be Equity (60) to Debt (40)
In other words, the Optimal Mix is here Equity : Total Long Term Financing is 60%
Current Market Value	2000	million	Fully Financed by Equity
Capital Mix Options	Option 1	Option 2	Option 3	Option 4
Debt	500	800	1200	1500
Equity	1500	1200	800	500
Total Long term Sources of Funds	2000	2000	2000	2000
Equity/total	0.75	0.60	0.40	0.25
As the optimal mix has been determined to be at Equity : Debt at 60:40, Option 2 i.e. 1200 million Financed through Equity and 800 million financed through debt would be the desirable mix to achieve optimal Market Value.