As the debt ratio continues to increase the increased

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Unformatted text preview: increase, the increased debt and equity costs eventually cause the WACC to rise (after point M in Figure 11.3(a)). This behavior results in a U-shaped, or saucer-shaped, weighted average cost-ofcapital function, ka. A Graphical View of the Optimal Structure optimal capital structure The capital structure at which the weighted average cost of capital is minimized, thereby maximizing the firm’s value. Because the maximization of value, V, is achieved when the overall cost of capital, ka, is at a minimum (see Equation 11.11), the optimal capital structure is that at which the weighted average cost of capital, ka, is minimized. In Figure 11.3(a), point M represents the minimum weighted average cost of capital—the point of optimal financial leverage and hence of optimal capital structure for the firm. Figure 11.3(b) plots the value of the firm that results from substitution of ka in Figure 11.3(a) for various levels of financial leverage into the zero-growth valuation model in Equation 11.11. As shown in Figure 11.3(...
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This document was uploaded on 03/30/2014.

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