Capital Structure Policy


ACC00152 Business Finance Topic 8 Tutorial Answers

1. Define the optimal capital structure.
Optimal capital structure is the mix of debt and equity that maximises firm value. It is
also the point at which WACC is minimised.

2. Problem 6, page 506 of the textbook.
There are two different ways we could approach this problem:
1. We can use Eq. (16.3) to calculate the cost of equity using the cost of debt. However,
we need to know D/E but are given D/V:

(Think of it this way: Debt is 21% of value and value is made up of debt + equity.
Therefore, if value is 100, debt is 21 and equity must therefore be 79. Therefore D/E
is 21:79. We could also express this as a percentage: 21/79 = .2658… or 26.58…%
but we would have to round it off in that case.)
Then using Eq. (16.3):

With no debt, the WACC is equal to the unlevered equity cost of capital. As the firm
borrows at the lower cost of debt its equity cost of capital rises according to Eq.
(16.3). The net effect is that the firm’s WACC is unchanged.


édiscuss major theories of capital structure and their contributions to the debate surrounding the optimal capital structure

éappraise the likely consequences for firm value and shareholder wealth of changes in a firm’s capital structure

éidentify the factors that influence a firm’s capital structure choice and explain their impact on that choice.