Which one of these relationships will exist if a firm is operating under its optimal capital structure?
A)The net present value of the firm will equal zero.
B)The firm's cost of capital will equal the risk-free rate.
C)The present value of the financial distress costs will equal the present value of the tax shield on debt.
D)The value of the firm equal the maximum value obtainable according to the MM theories.
E)The firm will be financed with equal amounts of long-term debt and equity.

Question

Quizplus · Accepted Answer

When a firm operates under its optimal capital structure, the present value of the financial distress costs will equal the present value of the tax shield on debt. This means that the benefits of taking on debt (tax shield) will be equal to the costs associated with financial distress. This is when the firm has achieved the perfect balance of debt and equity financing. The other options are not necessarily true when a firm operates under its optimal capital structure.

Which One of These Relationships Will Exist If a Firm