5. Capital structure decisions and firm value Why focus on the optimal capital s

Question

5. Capital structure decisions and firm value Why focus on the optimal capital structure? A company's capital structure decisions address the ways a firm's assets are financed (using debt, preferred stock, and common equity capital) and is often presented as a percentage of the type of financing used As with all financial decisions, the firm should try to set a capital structure that maximizes the stock price, or shareholder value. This is called the optimal capital structure Which of the following statements regarding a firm's optimal capital structure is true? O The optimal capital structure maximizes the firm's cost of debt. O The optimal capital structure minimizes the firm's weighted average cost of capital. O The optimal capital structure maximizes the firm's cost of equity. O The optimal capital structure maximizes the firm's earnings per share (EPS)

Explanation / Answer

The following statement is true:

The optimal capital structure minimizes the firms weighted average cost of capital.

The following statements are true:

Interest paid on debt is deducted from a firms pre tax income thus reducing the amount of taxes that it owes.

In an event of liquidation, creditors will get claims over a firms assets before common shareholders.

An increase in debt financing beyond a certain point increases the risk of bankruptcy and financial distress.

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