The optimal capital structure is met when:

Question

Quizplus · Accepted Answer

The optimal capital structure is achieved when the tax savings from additional leverage just offset the costs of distress. This means that the firms should not be too heavily leveraged, otherwise, the costs of financial distress will outweigh the benefits of the interest tax shield. Therefore, additional borrowing should be undertaken only if the expected return on the new investment is greater than the rate of interest on the borrowed capital, and if financial distress costs do not exceed the tax benefits of debt financing.

The Optimal Capital Structure Is Met When