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
ka earnings before interest and taxes
the after-tax operating earnings available to the debt and
weighted average cost of capital Clearly, if we assume t...
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