10) Which of the following statements regarding a firm’s capital structure and l

Question

10) Which of the following statements regarding a firm’s capital structure and leverage is incorrect?

A. A firm can reduce (lower) its leverage by retiring its existing debt or buying back its outstanding stock.

B. A firm’s capital structure basically refers to how the firm’s total capital is financed between (long-term) debt and equity.

C. The optimal leverage is that particular mix of debt and equity at which the firm value would be maximized.

D. The Irrelevance Theory by Modigliani and Miller (M&M) says that without taxes a firm’s capital structure does not matter to the maximization of the firm value or the minimization of its overall cost of capital..

Explanation / Answer

Option A is incorrect

Leverage = Debt / Equity

If you retire debt -> Debt reduces -> Leverage reduces

If you retire stock -> equity reduces -> Leverage increases

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