Tangshan Mining Company Must Choose Its Optimal Capital Structure

question 43

Essay

Tangshan Mining Company must choose its optimal capital structure. Currently, the firm has a 40 percent debt ratio and the firm expects to generate a dividend next year of $4.89 per share and dividends are expected to grow at a constant rate of 5 percent for the foreseeable future. Stockholders currently require a 10.89 percent return on their investment. Tangshan Mining is considering changing its capital structure if it would benefit shareholders. The firm estimates that if it increases the debt ratio to 50 percent, it will increase its expected dividend to $5.24 per share. Because of the additional leverage, dividend growth is expected to increase to 6 percent and this growth will be sustained indefinitely. However, because of the added risk, the required return demanded by stockholders will increase to 11.34 percent.
(a) What is the value per share for Tangshan Mining under the current capital structure?
(b) What is the value per share for Tangshan Mining under the proposed capital structure?
(c) Should Tangshan Mining make the capital structure change? Explain.

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Definitions:

Activity Variance

A disparity that arises when the actual level of business activity differs from what was planned or expected.

Personnel Expenses

The costs associated with employing staff, including wages, salaries, benefits, and taxes.

Direct Labor

The wages of employees directly involved in the production of goods or services, considered a variable cost.

Activity Level

Activity level refers to the volume of production or operations in a business. It is a determinant in both variable costing and activity-based costing, impacting how costs are allocated and managed.