What is optimal capital structure?

What is optimal capital structure?

An optimal capital structure is the best mix of debt and equity financing that maximizes a company’s market value while minimizing its cost of capital. Minimizing the weighted average cost of capital (WACC) is one way to optimize for the lowest cost mix of financing.

What are the features of optimal capital structure?

An optimum capital structure has such a proportion of debt and equity which will maximise the wealth of the firm. At this capital structure the market price per share is maximum and cost of capital is minimum.

What is the best theory on capital structure and why?

The traditional theory of capital structure says that for any company or investment there is an optimal mix of debt and equity financing that minimizes the WACC and maximizes value. Under this theory, the optimal capital structure occurs where the marginal cost of debt is equal to the marginal cost of equity.

Which of the following is the assumption of the MM model on capital structure?

The firm has an infinite life is the assumption of the MM model on dividend policy. According to Miller and Modigliani Hypothesis or MM Approach, dividend policy has no effect on the price of the shares of the firm and believes that it is the investment policy that increases the firm’s share value.

What are the factors that influence optimal capital structure?

The key factors influencing capital structure decisions to be investigated include industry leverage, profitability, firm size, growth opportunities, asset tangibility, expected inflation, and stock market return.

Which of the following is irrelevant for optimal capital structure?

Solution(By Examveda Team) Flexibility is not a feature of an optimal capital structure. An optimal capital structure is the objectively best mix of debt, preferred stock, and common stock that maximizes a company’s market value while minimizing its cost of capital.

Which of the following approaches to the capital structure do Modigliani-Miller advocate?

The Modigliani and Miller approach to capital theory, devised in the 1950s, advocates the capital structure irrelevancy theory. This suggests that the valuation of a firm is irrelevant to the capital structure of a company. Rather, the market value of a firm is solely dependent on the operating profits of the company.

Is there any optimal capital structure as per NI?

available for equity shareholders after the payment of interest is called as “Net Income (NI). mix where the overall cost of capital is minimum. As per this approach the cost of capital is minimum at 100% level of debt, therefore the capital structure is optimized at the 100% debt level.

What is Modigliani and Miller model?

What Is the Modigliani-Miller Theorem (M&M)? The Modigliani-Miller theorem (M&M) states that the market value of a company is correctly calculated as the present value of its future earnings and its underlying assets, and is independent of its capital structure.

What is the need to maintain optimum working capital?

There is no standard rule for an Optimum Working Capital. The working capital requirements vary from industry to industry. Traditionally, Current Ratio (Current Assets: Current Liabilities) of 1.5 to 3 is considered to be comfortable liquidity position.

What is the Modigliani-Miller capital structure approach?

This approach believes there is no optimal capital structure, and that the valuation of the firm depends on its operating income. The Modigliani-Miller theory of capital structure developed in 1958 is based on the following assumptions:

What is Modigliani Miller theorem in economics?

Modigliani–Miller theorem. The Modigliani–Miller theorem (of Franco Modigliani, Merton Miller) is an influential element of economic theory; it forms the basis for modern thinking on capital structure.

What is the optimal capital structure for investors?

However, because investors are better off putting their money into companies with strong balance sheets, it makes sense that the optimal balance generally should reflect lower levels of debt and higher levels of equity. The Modigliani-Miller (M&M) theorem is a capital structure approach named after Franco Modigliani and Merton Miller.

What is Modigliani and Miller’s proposal without taxes?

Modigliani and Miller Approach: Two Propositions without Taxes. Proposition 1. With the above assumptions of “no taxes”, the capital structure does not influence the valuation of a firm. In other words, leveraging the company does not increase the market value of the company.