1. Capital structure decisions and firm value Aa Aa E Why focus on the optimal capital structure? Capital structure decisions involve the ways a firm's assets are financed and are often presented as a percentage of the type of financing used, such as debt, preferred stock, and common equity. As with all financial decisions, a firm should try to set a capital structure that maximizes the stock price, or shareholder value. This is called the optimal capital structure; it is also the debt-equity mix that: Maximizes the net income Maximizes the weighted average cost of capital (WACC) Minimizes the weighted average cost of capital (WACC) O Maximizes the dividends Understanding the impact of debt in the capital structure Suppose you are conducting a workshop on capital structure decisions and you want to highlight certain key issues related to capital structure. Your assistant has made a list of points for your session, but he thinks he might have made some mistakes. Review the list and identify which items are correct. Check all that apply. M M M M M M M M M M M M M M Workshop Talking Points An increase in debt financing decreases the risk of bankruptcy. 0 Risks of bankruptcy increase management spending on perquisites and increase agency costs. 0 An increase in debt financing beyond a certain point is likely to increase the cost of equity. 0 The pretax cost of debt increases as the firm's risk of bankruptcy increases. An increase in the risk of bankruptcy is likely to reduce the firm's free cash flows in the future