Question

# Moore Plumbing Supply Company Capital Structure Mort Moore founded Moore Plumbing Supply after returning from duty...

Finally, what recommendations would you make about the capital structure of Moore Plumbing Supply Company? Justify your answer.

Please see the table below. In the last column we have calculated the Weighted average cost of capital for the firm. The second row will help you understand the mathematics.

 Debt ratio kd ks Tax Rate Equity Ratio WACC Wd T Ws = 1 - Wd Wd x Kd x (1 - T) + Ws x Ks 0% 16% 40% 100% 16.00% 10% 9.00% 17.00% 40% 90% 15.84% 20% 9.25% 17.80% 40% 80% 15.35% 30% 9.75% 19.00% 40% 70% 15.06% 40% 10.50% 20.50% 40% 60% 14.82% 50% 12.00% 22.00% 40% 50% 14.60% 60% 15.00% 26.00% 40% 40% 15.80% 70% 20.00% 30.00% 40% 30% 17.40% 80% 30.00% 40.00% 40% 20% 22.40% 90% 50.00% 60.00% 40% 10% 33.00%

If you examine the WACC from top to bottom, you will realize that WACC of the firm first decreases with increase in debt ratio, achieves a minimum and then starts increasing.

The WACC is minimum at the debt ratio of 50%. At this debt ratio, WACC is 14.60%. At this WACC, the value of the firm will be maximum.

Hence, Moore Plumbing Supply Company should follow a capital structure with 50% debt ratio.

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