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Nilanjan Bhowmick AIR 3, CSIR NET (Earth Science)
Nisha Sharma posted an Question
October 16, 2021 • 15:20 pm
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30 points
30 points
- UGC NET
- Commerce
E cost of equity (k) increases. assumptions the rate of interest on debt remains constant for a certain period and thereafter with an increase inleverage. the e
e cost of equity (K) increases. Assumptions The rate of interest on debt remains constant for a certain period and thereafter with an increase inleverage. The expected rate by equity remains constant or increase gradually. After that, the equity shareholders start perceiving a financial risk and then from the optimal point and the expected rate increases speedily. Asa result of the activity of rate of interest and expected rate of return, the WACC first decreases and then increases. The lowest point on the curve is optimal capital structure. Cost of Equity (K) Cost of capital WACC (K) /Cost of Debt (K) Optimum Level of Capital Degree of Leverage Fig. WACC and Optimum Leverage Pproach to capital theory, devised in the 1050n
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What Is Optimal Capital Structure? The optimal capital structure of a firm is the best mix of debt and equity financing that maximizes a company’s market value while minimizing its cost of capital. In theory, debt financing offers the lowest cost of capital due to its tax deductibility. However, too much debt increases the financial risk to shareholders and the return on equity that they require. Thus, companies have to find the optimal point at which the marginal benefit of debt equals the marginal cost. KEY TAKEAWAYS An optimal capital structure is the best mix of debt and equity financing that maximizes a company’s market value while minimizing its cost of capital. Minimizing the weighted average cost of capital (WACC) is one way to optimize for the lowest cost mix of financing. According to some economists, in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, in an efficient market, the value of a firm is unaffected by its capital structure.