The optimal capital structure of a firm is a function of the?

Question

The optimal capital structure of a firm is a function of the __________.
a.business risk of the firm
b.tax structure
c.a and b
d.none of the above

Answer 1

C.

The risk will determine how much is too much risk. If the firm is cyclic, then the amount of debt should be lower so that the firm can still make interest payment during the down times.

The tax structure determines the amount of tax shield and also factors into the optimal capital structure. More tax means more debt.

Edit: By the way, Mark, I've gone through your papers a few years back and they were rather interesting. I would have sent an email, but you don't have your up here on Answers and I didn't really want to invade your privacy by going through other channels.

Answer 2

C.

Higher taxes give a company more of an advantage to having debt -- because payments to debtholders are tax deductible (while payments to equity investors are not).

Business risk is also a factor. The more debt you have, the higher the probability of defaulting (going bankrupt). If deadweight costs of bankruptcy are high then you don't want too much debt & need to back away. Deadweight costs include legal fees, accounting fees, loss of business because no one wants to buy from you if you go out of business, inability to get parts because crditors want cash, etc.

Answer 3

the undemanding theorem states that, below a definite marketplace value technique (the classical random walk), interior the absence of taxes, financial disaster expenses, and uneven tips, and in an effective marketplace, the fee of a company is unaffected by potential of ways that organization is financed. Taxes advise that there are reward for corporations to apply debt, seeing that firms can deduct interest money. consequently leverage lowers tax money.