The best mix of debt and equity inside the organization determines the optimal capital structure, which enhances a firm's overall worth (Brigham & Ehrhardt, 2020). Retained earnings, debt, equity, and preferred stock make up this ideal capital structure. Finding the ideal capital structure, which entails figuring out the proportion of debt that optimizes shareholder earnings, is a critical task for financial managers. Financial managers need to reduce the weighted average cost of capital in order to attain the lowest cost mix of financing (Hayes, 2022).

The ideal capital structure for a business should be in line with its growth objectives, capital expenditures, and operational performance. To avoid sending the wrong signals to the market, a company should ideally give debt financing priority over equity when seeking to raise money (Hayes, 2022). Often, capital investments are required to successfully execute expansion objectives. A company with consistent and reliable cash flow may safely manage its debt, follow its current growth objectives, and achieve the desired operating results, including operating income.

Brigham, E. F., and Ehrhardt, M. C. (2020). Financial management: Theory and practice [with MindTap] (16th ed.). Cengage Learning. ISBN-13: 9780357252680

Hayes, A. (2022, April 25). Optimal capital structure definition: Meaning, factors, and limitations. Investopedia. https://www.investopedia.com/terms/o/optimal-capital-structure.asp

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