“The optimal capital structure of a firm is often defined as the proportion of debt and equity that results in the lowest weighted average cost of capital (WACC) for the firm” (“Capital Structure”, n.d.). Industries such as banking and insurance use a considerable amount of leverage which causes their business models to require a significant amount of debt. Thinking like a bank can be a way to help a manager decide optimal debt-to-equity levels. “Companies have to find the optimal point at which the marginal benefit of debt equals the marginal cost” (Hayes, 2020).
Capital is required for capital expenditure and also to grow the company. The company would have an optimal capital structure allowing the cost of funds to be not too high. It would also be easier to generate a higher return, and easier to make capital budgeting decisions based on the optimal capital structure of the company. The operating results of the company would be better based on not paying a lot on interest expenses and increasing tax benefits and values of shareholders.
Capital Structure. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/finance/capital-structure-overview/
Hayes, A. (2020). Optimal Capital Structure. Retrieved from https://www.investopedia.com/terms/o/optimal-capital-structure.asp
How would a financial manager determine optimal capital structure?
How would it fit in with the company’s capital expenditures, growth plans, and operating results?
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