The optimal capital structure has been achieved when the:
A)weight of equity is equal to the weight of debt.
B)debt-to-equity ratio selected results in the lowest possible weighted average cost of capital.
C)firm is totally financed with debt.
D)debt-to-equity ratio is such that the cost of debt exceeds the cost of equity.
E)cost of equity is maximized.

Question

Quizplus · Accepted Answer

The optimal capital structure is the one that results in the lowest possible weighted average cost of capital (WACC). This means that the debt-to-equity ratio must be selected in such a way that the cost of debt and the cost of equity are balanced in a way that results in the lowest possible WACC. A balance between debt and equity needs to be maintained to ensure financial sustainability and stability of the business. Option A is incorrect because the equity and debt weightages may differ depending on the business and market conditions. Option C is incorrect because extending complete debt financing can risk the bankruptcy and/or insolvency of the firm. Option D is incorrect because if the cost of debt exceeds the cost of equity, then raising debt wouldn't be wise as it may give rise to financial distress. Option E is incorrect because maximizing the cost of equity would result in higher WACC and, hence, an unattractive capital structure.

The Optimal Capital Structure Has Been Achieved When The