In theory, the firm should maintain financial leverage consistent with a capital structure that
A) meets the industry standard.
B) maximizes the earnings per share.
C) maximizes the owner's wealth.
D) maximizes dividends.

Question

Quizplus · Accepted Answer

The objective of maximizing shareholder wealth is the ultimate goal of any financial decision-making, and this includes the capital structure decision. Financial leverage, or the use of debt financing, can amplify returns to equity holders, but it also increases the risk of financial distress or bankruptcy. Therefore, the firm should balance the benefits and costs of financial leverage and maintain a capital structure that maximizes shareholder wealth, which is a long-term goal that incorporates both risk and return considerations. Maximizing earnings per share, industry standards, or dividends may not necessarily be consistent with the goal of shareholder wealth maximization, and thus, they should not be the primary drivers of capital structure decisions.

In Theory, the Firm Should Maintain Financial Leverage Consistent with a Capital