A firm should select the capital structure which:
A) produces the highest cost of capital.
B) maximizes the value of the firm.
C) minimizes taxes.
D) is fully unlevered.
E) has no debt.

Question

Quizplus · Accepted Answer

The primary objective of a firm is to maximize the value of the firm for its shareholders. Therefore, the capital structure should be chosen in a way that maximizes the value of the firm. This can be achieved by balancing the use of debt and equity in such a way that the cost of capital is minimized while maintaining an optimal level of risk for the firm. Choosing a capital structure that produces the highest cost of capital (A) or has no debt (E) may result in a too conservative approach, while choosing a fully unlevered structure (D) may not be optimal for maximizing value. Additionally, minimizing taxes (C) should be considered, but it should not be the primary driver of the capital structure decision.

A Firm Should Select the Capital Structure Which