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    Determinants and benefits of Optimal Capital Structure

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    What external factors affect the optimal capital structure?
    What is the benefit of being at the optimal capital structure?

    © BrainMass Inc. brainmass.com March 4, 2021, 6:02 pm ad1c9bdddf
    https://brainmass.com/business/capital-structure-and-firm-value/determinants-benefits-optimal-capital-structure-24709

    Solution Preview

    External factors include macro-economic factors
    In good economic times, firms will generate higher earnings and be able to service more debt. In recessions, earnings will decline and with it the capacity to service debt. In fact, both the level of risk-free rate and the magnitude of default spreads can affect optimal debt ratios.

    (a) Level of Interest Rates
    As interest rates decline, debt becomes cheaper and more attractive. While this may seem intuitive, the effect is muted by the fact that lower interest rates also reduce the cost of equity. In fact, changing the risk-free rate has a ...

    Solution Summary

    The solution explains various factors affecting the choice for optimal capital stucture and how the optimal capital struture helps the organizations. The solution has approx 400 words and presents examples of various situations.

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