Generally speaking, the cost of debt is cheaper than the cost of equity. Does it imply...

Generally speaking, the cost of debt is cheaper than the cost of equity. Does it imply that a firm should increase its debt-to-equity ratio to as high as possible such that its corporate cost of capital can be minimized?

Expert Solution

In order to minimize WACC, the capital structure must consist of a balanced combination of debt and equity.

IF we incrrease Debt tp equity ratio, means a business takes on more and more debt, its probability of defaulting on its debt increases. if the debt of a company is high this means the equity shareholder will demand more retrun whioch will then increase the cost of equity so eventually increasing more debt will again increasce the WACC rather. which would be reduced if optimal mix could be used.

The optimal capital structure is one that minimizes the Weighted Average Cost of Capital (WACC) by taking on a mix of debt and equity.

The cost of debt is cheaper than the cost of equity. It does not imply that a firm should increase its debt-to-equity ratio to as high as possible such that its corporate cost of capital can be minimized.

For any clarification comment.

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jeff jeffy answered 1 year ago

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