2. Optimal Capital structure
• Capital structure is the proportion of debt and
preference and equity shares on a firm’s
balance sheet.
• Optimal Capital structure is the capital
structure at which the weighted average cost
of capital is minimum and thereby maximum
value of the firm.
3. Features
The relationship of debt and equity in an optimal capital
structure is made in such a manner that the market value per
equity share becomes maximum.
It maintains the financial stability of the firm.
The finance manager determines the proportion of debt and
equity in such a manner that the financial risk remains low.
The advantage of the leverage offered by corporate taxes is
taken into account in achieving the optimal capital structure.
Borrowings help in increasing the value of company leading
towards optimal capital structure.
The cost of capital reaches at its minimum and market price of
share becomes maximum at optimal capital structure.
4. Constraints
• The optimum debt-equity mix is difficult to ascertain in true sense.
• The concept of appropriate capital structure is more realistic than
the concept of optimum capital structure.
• It is difficult to find an optimum capital structure as the extent to
which the market value of an equity share will fall due to increase
in risk of high debt content in capital structure, is very difficult to
measure.
• The market price of equity share rarely changes due to changes in
debt-equity mix, so there cannot be any optimum capital
structure.
• It is impossible to predict exactly the amount of decrease in the
market value of an equity share because market factors that
influence market value of equity share are highly complex.
