Introduction to capital structure theory

In his private office, just down the hall from his conference room, the Chief Financial Officer $($CFO$)$ of Caberto Chemicals is meeting with his newly hired assistant, Annie.

CFO: Before our next meeting with the bankers, let's take a second and make sure that we have a common understanding about the company's capital structure. Caberto can potentially have three different capital structures: its current, actual capital structure, a target capital structure, and an optimal capital structure. If we wanted to talk about the observed capital structure at which Caberto actually exhibits today or any other specific point in time, we'd be talking about which capital structure, Annie?

ANNIE: We'd be talking about Caberto's $$ capital structure. This is the capital structure that Caberto is currently exhibiting, and it can differ from its ideal capital structure.

CFO: Very good. Now, if Caberto's current capital structure consists of $35\%$ debt and $65\%$ common equity, then, Annie, how would we know if we are operating with our optimal capital structure?

ANNIE: An optimal capital structure is characterized by two important attributes: First, it minimizes the firm's

$,$ and second, it maximize: $,$ which should make our shareholders very happy.