Question

If a company's existing capital structure is not optimum, should the company take on more debt, repurchase stock, have a seasoned equity offering? why or why not? Please provide a detailed explanation.

Answer 1

A optimum capital structure is a state of capital structure at which debt is used to maximum level at which cost of borrowing is less and overall cost of capital is minimum. over all cost of capital can be minimized by using the debt to the maximum extent upto which cost of debt is minimum. Maximum use of debt from will reduce the share of equity in capital structure (which is costlier source of finance) and increase the weight of debt ( a cheaper source of finance).Optimum capital structure is a capital structure at which overall cost of capital is minimum and value of the firm is maximum.

value of firm = operating profit/overall cost of capital

Yes if the existing capital structure is not optimum a company should take more of debt and from the proceeds should repurchase the stock to reduce the overall cost of capital, this will create maximum value of firm because from this act overall cost of capital will decrease and value of firm will be maximized so at optimal capital structure value of firm is maximum and overall cost of capital is minimum