The optimal capital structure of a firm is that combination of debt and equity that provides the highest overall cost of capital,or the highest WACC.

Question

Quizplus · Accepted Answer

The optimal capital structure of a firm is that combination of debt and equity that provides the lowest overall cost of capital, or the lowest WACC (weighted average cost of capital). This is because as the proportion of debt in the capital structure increases, the cost of debt (interest payments) remains fixed, but the cost of equity increases due to higher risk. Eventually, the WACC will reach a minimum point, where the cost of debt and equity is balanced. Therefore, the statement in option A is incorrect.

The Optimal Capital Structure of a Firm Is That Combination