The optimal capital structure has been achieved when the:
a.debt-equity ratio is equal to 1.
b.weight of equity is equal to the weight of debt.
c.of equity is maximized given a pre-tax cost of debt.
d.debt-equity ratio is such that the cost of debt exceeds the cost
of equity.
e.debt-equity ratio results in the lowest possible weighted average
cost of capital.
a.debt-equity ratio is equal to 1.
b.weight of equity is equal to the weight of debt.
c.of equity is maximized given a pre-tax cost of debt.
d.debt-equity ratio is such that the cost of debt exceeds the cost
of equity.
e.debt-equity ratio results in the lowest possible weighted average
cost of capital.
Answer
The optimal capital structure is that structure in which the debt and equity are in the proportion which result in the minimum weighted average cost of capital (Weight of debt x After-tax cost of debt) = |-( weight of preferred stock x Cost of preferred stock Weighted average cost of capital (waCC) Weight of equity x Cost of equity) The cost of equity, cost of debt, and after-tax cost of debt might be different for the different firms. So, based on the cost of each source of finance and weightage (proportion) is used to calculate the weightage average cost of capital. And every firm wants to maximize returns and minimize costs and cost of capital. Therefore, the option (a), (b), (c), and (d) will not result in the lowest cost of capital. The optimal capital structure result in the lowest cost of capital in which the weighted average cost of capital is be minimum Hence, the correct option is ption (e) Debt-equity ratio res possible weighted average cost of capital
