The optimal capital structure has been achieved when the:
A) Debt-equity ratio is equal to 1.
B) Weight of equity is equal to the weight of debt.
C) Cost of equity is maximized given a pre-tax cost of debt.
D) Debt-equity ratio is such that the cost of debt exceeds the cost of equity.
E) Debt-equity ratio selected results in the lowest possible weighed average cost of capital.

Question

Quizplus · Accepted Answer

The optimal capital structure is achieved when the firm has balanced its debt and equity in such a way that the weighted average cost of capital (WACC) is minimized. This does not necessarily mean equal weights of debt and equity (as in B), a specific debt-equity ratio like 1 (as in A), or situations where the cost of debt exceeds the cost of equity (as in D) or the cost of equity is maximized (as in C). Lowering the WACC increases the value of the firm and is thus considered optimal.

The Optimal Capital Structure Has Been Achieved When The