The optimal capital structure of a ﬁrm maximizes the value of the ﬁrm while:
A) Maximizing the interest tax shield.
B) Minimizing the ﬁrm's cost of capital.
C) Equating the level of debt to the level of equity.
D) Minimizing the debt-equity ratio.
E) Minimizing the ﬁnancial distress costs.

Question

Quizplus · Accepted Answer

The optimal capital structure is the one that minimizes the firm's cost of capital. This means finding the right mix of debt and equity to achieve the lowest possible cost of funding for the firm. Maximizing the interest tax shield (A) or minimizing the debt-equity ratio (D) may not necessarily lead to the lowest cost of capital. Equating the level of debt to the level of equity (C) is not a practical or desirable goal for most firms. Minimizing the financial distress costs (E) is important, but it is not the primary goal of optimizing the capital structure.

The Optimal Capital Structure of a ﬁRm Maximizes the Value