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Capital Structure Firms

The capital structure of a firm is a crucial decision that executives must make. In fact, the question that is highly related to the capital budgeting decision was discussed last week. That is after we have decided that a particular project is worth more than it costs we must determine how to finance its acquisition, either by selling debt or equity.

Discuss the influence of taxes and bankruptcy costs on the optimal capital structure. If you were the current CFO of Rite-Aid Pharmacy, how would these considerations guide your decision making in the near future as you consider RA's capital structure?

Please explain in detail

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The influence of taxes and bankruptcy costs on the optimal capital structure:

An optimal capital structure is one in which a balance between risks and returns are attained in manner to maximize the stock price of a firm. The general purpose why companies are in existence is so as to maximize the wealth of the shareholders. The company is able to do so through acquiring assets whose worth are much more than the costs of the project and utilizing these capital assets to meet customer needs. These capital acquisitions are often either through debt financing or through equity financing. A capital structure of a company connotes the mixture in the way that a company finances such capital acquisitions (Baker & Martin, 2011). This paper evaluates the influence of taxes and bankruptcy costs on the optimal capital structure.

The influence of taxes and bankruptcy costs on the optimal capital structure:

As noted above an optimal capital structure is one in which a balance between risks and returns are attained in manner to maximize the stock price of a firm. It is one which reduces the price of capital and increases firm value. Taxes and bankruptcy costs impact the cost of capital and therefore in essence also influence the optimal structure that can be attained in a firm.

There are four parties that often have claim over a firm's capital and income; these are the stockholders through equity, the government through taxes, the creditors through debt and the bankruptcy claims through indirect costs. Since companies cannot be able to directly influence the claims on taxes and bankruptcy costs, ...

Solution Summary

Capital structure firms are examined.

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