Which of the following statements is CORRECT? a. The optimal capital structure s

Question

Which of the following statements is CORRECT?

a. The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.

b. The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.

c. The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, ans the WACC.

d. The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. e. As a rule, the optimal capital structure is found by determining the debt-equity that maximizes expected EPS.

Please, not only give the right answer, but also a detailed explanation. It is vital in this task.

Explanation / Answer

The correct answer is : a. The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.

Capital Structure determines the extent of Equity and Debt structure. If debt to equity ratio is higher, the cost of debt will be higher which will result in lower EPS and increased cost of debt will result in higher WACC.

WACC consists of Cost of Debt, cost of equity and cost of preference stock.

If capital Structure is optimal, it will have lower debt obligation resulting in lower minimized WACC.

If cost of debt is low, this will result in higher profit and EPS will be higher.

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