Which one of these relationships will exist if a firm is operating under its optimal capital structure?
A)The net present value of the firm will equal zero.
B)The firm's cost of capital will equal the risk-free rate.
C)The present value of the financial distress costs will equal the present value of the tax shield on debt.
D)The value of the firm will equal the maximum value obtainable according to the MM theories.
E)The firm will be financed with equal amounts of long-term debt and equity.

Question

Quizplus · Accepted Answer

When a firm is operating under its optimal capital structure, the present value of the tax shield on debt will be equal to the present value of the financial distress costs. This means that the firm is utilizing an appropriate balance of debt and equity to maximize its value. The other options are not necessarily true in this scenario. The net present value of the firm may or may not be zero, and the firm's cost of capital will depend on the specific financing choices. The value of the firm may or may not be at the maximum according to MM theories, and there is no requirement for equal amounts of long-term debt and equity.

Which One of These Relationships Will Exist If a Firm