The optimal capital structure is met when:

Question

Quizplus · Accepted Answer

The optimal capital structure occurs when the tax benefits from debt are equal to the costs of financial distress. If additional borrowing results in lower financial distress costs, the firm may benefit from increasing leverage further. However, excessive debt can lead to higher bankruptcy costs and increased financial distress, which can ultimately decrease firm value. Therefore, the optimal capital structure is achieved when the tax savings from additional leverage is just offset by the costs of distress.

The Optimal Capital Structure Is Met When