Question

According to the traditional approach to capital​ structure, the value of a firm will be maximized when​ ________. A. the financial leverage is maximized B. the weighted average cost of capital is minimized C. the dividend payout is maximized D. the cost of debt is minimized

Answer 1

Answer:

B. the weighted average cost of capital is minimized

Explanation:

• The traditional approach to the capital structure shows that there exists an optimal debt to an equity ratio referring to the overall cost of the capital that is minimum and the market values of a form are the maximum.
• On either side of the curve the changes in financial mix can positive and bring a positive change to the values of the firm. Hence the firm will have an minimized average cost of capital.

Answer 2

Answer:

B. the weighted average cost of capital is minimized

Explanation:  

As per the traditional capital structure theory, as a firm employs more and more debt in it's capital structure, the financial leverage increases and since debt being a cheaper source of finance than equity with interest paid on debt being a tax deductible expense, the overall cost of capital initially falls.

As the firm further keeps increasing the proportion of debt, such debt raises the expectations of equity stockholders which raises the cost of equity and thus the overall cost of capital begins to rise.

An optimal capital structure under the theory refers to the one at which, overall cost of capital or the weighted average cost of capital of the firm is the lowest and value of the firm is the highest.