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A beneficial rule to follow is to set the firm's capital structure so that the firm's value is minimized.
Firm's Optimal capital structure
- In corporate finance, capital structure refers to the combination of several external funding sources, also known as capital, utilized to finance a company. It is listed on the balance sheet of the company and comprises equity owned by shareholders, debt, and preferred shares.
- The best combination of debt and equity financing for a company's capital structure optimizes market value while lowering the cost of capital. Theoretically, because debt financing is tax deductible, it has the lowest cost of capital.
- The best combination of debt and equity financing that increases market value while lowering a company's cost of capital is known as an optimal capital structure.
- One strategy to optimize for the lowest cost mix of financing is to reduce the average cost of capital.
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