Aa Aa 2. Capital structure decisions and firm value Why focus on the optimal capital structure? A company's capital structure decisions address the ways a firm's assets are financed-using debt, preferred stock, and common equity capital- and a firm's capital structure is often described using percentages of each type of capital used (e.g., 30% debt, 10% preferred stock, and 60% common equity). As with all financial decisions, a firm should attempt to implement a capital structure that maximizes its stock price, or shareholder value. This is called the optimal capital structure. 7- ited Which of the following statements regarding a firm's optimal capital structure is true? The optimal capital structure minimizes the firm's weighted average cost of capital. The optimal capital structure maximizes the firm's cost of debt. The optimal capital structure maximizes the firm's cost of equity. The optimal capital structure maximizes the firm's earnings per share (EPS). 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 Identity which items are correct. Check all that apply. 06 An increase in debt financing beyond a certain point is likely to increase a firm's cost of equity. Risks of bankruptcy increase management's spending on perquisites and increase agency costs. An increase in debt financing decreases the risk of bankruptcy. The pretax cost of debt increases as a firm's risk of bankruptcy increases There is a hierarchy of creditors in the event of bankruptcy, and bondholders have a claim that is senior to the claims of a firm's preferred and common shareholders