A ﬁrm should select the capital structure which:
A) Produces the highest cost of capital.
B) Maximizes the value of the ﬁrm.
C) Minimizes taxes.
D) Is fully unlevered.
E) Has no debt.

Question

Quizplus · Accepted Answer

The goal of a firm is to maximize the value of the firm, so the capital structure that maximizes the value of the firm should be selected. A capital structure with some amount of debt can provide a tax advantage due to the tax deductibility of interest payments, but too much debt can increase the risk of bankruptcy and result in a higher cost of capital. Therefore, the optimal capital structure should balance the benefits of debt with the costs of financial distress.

A ﬁRm Should Select the Capital Structure Which