Optimal Capital Structure

The optimal capital structure for a company involves a blend of debt and equity financing. This combination minimises the average cost of capital, enhancing the overall value of the company. Debt financing is more cost-effective due to the ability to deduct interest payments from taxable income, unlike dividends paid to shareholders. However, an overreliance on loans poses the risk of increased bankruptcy likelihood, potentially harming the company's value. Therefore, an ideal combination comprises a mix of low-cost loans and sufficient internal capital to mitigate repayment risks. Determining the precise composition can be challenging, so businesses typically target a range of values.