Figure: Cost Functions and Value: Capital costs and the optimal capital structure V*

Valuevalue of the firm

Cost of equity Cost of Debt Annual Cost (%) WACC

M* = Optimal Capital Structure Gearing Level

Source: (Gitman & Hennessey, 2004)

Graphical View of Optimal Capital Structure

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Finding Optimal Capital StructureThe firms optimal capital structure can be determined two ways:Minimizes WACC.Maximizes EPS.

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Table for calculating WACC and determining the minimum WACC D/A ratio 0.00% 12.50 25.00 37.50 50.00WACC 12.00% 11.55 11.25 11.44 12.00E/A ratio100.00% 87.50 75.00 62.50 50.00

ks 12.00% 12.51 13.20 14.16 15.60

kd (1 T) 0.00% 4.80 5.40 6.90 8.40Amount borrowed$ 0 250 500 750 1,000* Amount borrowed expressed in terms of thousands of dollars