When the negative future outlook becomes known to the

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Unformatted text preview: c information exist from time to time, firms should maintain some reserve borrowing capacity by keeping debt levels low. This reserve allows the firm to take advantage of good investment opportunities without having to sell stock at a low value and thus send signals that unduly influence the stock price. The Optimal Capital Structure What, then, is an optimal capital structure, even if it exists (so far) only in theory? To provide some insight into an answer, we will examine some basic financial relationships. It is generally believed that the value of the firm is maximized when the cost of capital is minimized. By using a modification of the simple zerogrowth valuation model (see Equation 7.3 in Chapter 7), we can define the value of the firm, V, by Equation 12.11. V EBIT (1 ka T) (12.11) where EBIT EBIT T (1 T) ka earnings before interest and taxes tax rate the after-tax operating earnings available to the debt and equity holders weighted average cost of capital Clearly, if we assume t...
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This document was uploaded on 01/19/2014.

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