What is Optimal Capital Structure?
“The optimal capital structure is estimated by calculating the mix of debt and equity that minimizes the weighted average cost of capital (WACC) while maximizing its market value. The lower the cost of capital, the greater the present value of the firm’s future cash flows, discounted by the WACC. Thus, the chief goal of any corporate finance department should be to find the optimal capital structure that will result in the lowest WACC and the maximum value of the company (shareholder wealth).”
“According to economists Modigliani and Miller (M & M, 1950), in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information; and in an efficient market, the value of a firm is unaffected by its capital structure (the market value of a firm is determined by its earning power and the risk of its underlying assets) . We know that in reality firms do face these obstacles.
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