Question

does an optimal capital structure exist

Answer 1

It is very important for companies to keep its capital structure at a stable and in a good manner. Capital structure can be defined as the combination of the asset with the equity and debt. This is the financing process of making combination of assets with equity and debt. It will helps the company to identify which kind of funding is needed for the company and how much portion of debt and equity should the company keeps according to the asset.

So now we can discuss about the optimal capital structure. Optimal capital structure is used for minimizing the cost of capital. Optimal capital structure is the best mix of equity and debt. This will helps to increase the firms market value because here there is the best equilibrium point of capital structure that makes the best cost structure for the firm.

But it is a question that does an optimal capital structure exist? We should seriously think about it. Firms genarelly uses equity and debt components for generating capital for the running of business. Equity portfolios contains high risk so the return is also high. But in case of debt the risk and cost are very lower. We use weighted average cost of capital for findout the cost of the capital and by that we can concluded to the optimal capital structure. A low WACC shows more better working. So as per this traditional theory it is believed that optimal capital structure is exist. But there is an opposition for this that the Modigliani and Millerdeveloped a theory that argued the capital structure of a firm does not have an impact on WACC and the overall value of the firm is constant and shareholder wealth cannot be enhanced by altering the debt to equity ratio therefore no optimal capital structure exists. So as per this theory he strongly believe that the perfect market knowledge is can not acheivable by the firms all the time and the investors mind also not predictable and so he argued that optimal capital strucure is not exist.

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