The optimal capital structure has been achieved when the:
A)debt-equity ratio is equal to 1.
B)weight of equity is equal to the weight of debt.
C)cost of equity is maximized given a pretax cost of debt.
D)debt-equity ratio is such that the cost of debt exceeds the cost of equity.
E)present value of the financial distress costs equals the present value of the tax shield on debt.

Question

Quizplus · Accepted Answer

The optimal capital structure is achieved when the present value of the tax shield on debt equals the present value of the financial distress costs. This means that the company should use an appropriate level of debt to maximize the benefits of the tax shield but not to the extent that the costs of financial distress outweigh the benefits. Therefore, option E is the correct answer.

The Optimal Capital Structure Has Been Achieved When The