2. Capital structure decisions and firm value Aa Aa 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 try to establish 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 firm's dividends Minimizes the firm's weighted average cost of capital Maximizes the company's net income Maximizes the firm's weighted average cost of capital 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. An increase in debt financing beyond a certain point increases the risk of bankruptcy and financial distress. An increase in debt financing increases the taxes that a company owes A decrease in debt financing increases the risk of bankruptcy, and managers are encouraged to invest in high-risk projects. In an event of liquidation, creditors will get their claims over a firm's assets before common shareholders. Interest paid on debt is deducted from a firm's pretax income, thus reducing the amount of taxes that it owes