The traditional theory of capital structure says that a firm’s value increases to a certain level of debt capital, after which it tends to remain constant and eventually begins to decrease if there is too much borrowing. This decrease in value after the debt tipping point happens because of overleveraging.

Why should a firm aim at a balanced capital structure?

A properly designed capital structure ensures the determination of the financial requirements of the firm and raise the funds in such proportions from various sources for their best possible utilisation. A sound capital structure protects the business enterprise from over-capitalisation and under-capitalisation.

Does a firm need both components of capital structure?

A company will need to weigh its absolute cost of capital vs. its risk of defaulting, so that an optimal capital structure will include both debt and equity.

What should be the target capital structure for a company?

Select One: A. Obtain The Highest Possible Bond Rating. B. Maximize The Earnings Per Share (EPS). C. Minimize The Cost Of Equity (rs). D. Minimize The Weighted Average Cost Of Capital (WACC).

Which is a necessary condition of an optimal capital structure?

The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. d.

What are the benefits of a capital structure?

The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. b. The capital structure that minimizes the required return on equity also maximizes the stock price. The capital structure that minimizes the WACC also maximizes the price per share of common stock.

Which is capital structure maximizes the stock price?

The capital structure that minimizes the required return on equity also maximizes the stock price. The capital structure that minimizes the WACC also maximizes the price per share of common stock. d. The capital structure that gives the firm the best credit rating also maximizes the stock price.