How would the cost of capital change if the capital structure changed.
If the company needs a split of 25% debt to 75% equity to have an optimal capital structure, would that be optimal.
What would happen to the cost of capital if it is not optimal and the firm moves to optimal.
Capital strucutre is the proportion of debt to equity in the firm's balance sheet. The objective of the capital structure management is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). It has to optimally utilize the sources of finances which broadly are equity and Debt.
Cost of capital comprises weighted average cost of debt and equity. Cost of capital reduces if the firm uses debt initially . This is because the after-tax cost of debt is lower than equity for many corporations. This is because it reduces a company's tax liability because interest payments are deductible expenses.
But as there is increase in debt ...
Impact of capital structure on cost of capital