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 is often presented as a percentage of the type of financing used. As with all financial decisions, the firm should try to set a capital structure that maximizes the stock price, or shareholder value. This is called the optimal capital structure. Which of the following statements regarding a firm's optimal capital structure is true? The optimal capital structure maximizes return on equity. The optimal capital structure minimizes the cost of equity. The optimal capital structure maximizes the firm's cost of debt. The optimal capital structure minimizes the firm's price-to-earnings ratio. 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. Workshop Talking Points Check all that apply. An increase in debt financing beyond a certain point is likely to increase the firm's cost of equity. Risks of bankruptcy increase management spending on perquisites and increase agency costs. An increase in the risk of bankruptcy is likely to reduce a firm's free cash flows in the future. An increase in debt financing decreases the risk of bankruptcy. The pre-tax cost of debt increases as a firm's risk of bankruptcy increases