What determines the optimal mix of equity and debt finance for firms PDF

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What determines the optimal mix of equity and debt finance for firms. Both equity and debt are sources of finances which firms require to finance projects which are expected to yield positive NPVs. However, both these sources of finance have a cost which is known as the cost of capital. Empirical evidence have shown that the optimal capital structure of a firm, i.e the mix of equity and debt is there its Weighted Average Cost of Capital (WACC) is lowest. There are various factors which determine the cost of each type of capital and these are discussed hereunder. The WACC The components of financing: debt, Equity or Preferred Stock. The cost of each component.

WACC= Ke (E/D+E) + K d ( D/D +E)

How do we measure Ke ? CAPM = Rf + β(Rm-Rf) Determinants are Beta, Expected return on market. (systematic and unsystematic risk) Cost of Preference shares ? Using IRR How do we measure Kd ? Redeemable stock Irredeemable stock. Use of IRR. Market value used in Weighted average method. Examples Limitations Conclusion...