Consider the following statements: When choosing a capital structure, the objective of the firm should be: I. Choose the one that maximises the current value of the firm’s bonds II. Choose the one that minimises the firm’s weighted average cost of capital III. Choose the one that results in the largest tax shield IV. Choose any capital structure since capital structure is always irrelevant Which of the statements is TRUE? a. I only b. II only c. I and II only d. I, II and IV only e. I, III and IV only
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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