Tangshan Mining Company Must Choose Its Optimal Capital Structure

question 66

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 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.

---

Definitions:

Transferred Out

In a process costing environment, it refers to goods that have been completed in one department and moved to the next stage in the production process.

Production Costs

The total expenses incurred in the process of manufacturing or producing goods, including labor, materials, and overhead costs.

Conversion Costs

Costs incurred during the transformation of raw materials into finished products, comprising of direct labor and manufacturing overhead.

Weighted-Average Method

A cost accounting method that calculates the cost per unit of inventory by considering both the cost of existing inventory and the cost of new inventory acquired, weighted by their respective quantities.