33.2.2 Optimal and Target Capital Structures

Question 1

· Static trade-off theory of capital structure - a theory that states …

Answer 1

The optimal level of debt is found at the point where additional debt would cause the costs of financial distress to increase by a greater amount than the benefit of the additional tax shield.

Question 2

The present value of financial distress costs:

Answer 2

VL = VU + tD − PV (Costs of financial distress)

Question 3

· Calculating capital structure weights:

Answer 3

D/(D + E)

Question 4

· A simple way of transforming a debt-to-equity ratio (D/E) into a weight is:

Answer 4

D/E /( 1 + D/E)

Question 5

· Debt and equity weight:

Answer 5

Wd = d / d + e

We = e / d + e