Question

Asked Nov 1, 2019

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You are a management trainee in one of the Manufacturing companies based in Johor, Malaysia. The company was established in 2003 and recently has been listed in Bursa Malaysia. Currently, the debt-equity ratio of the company is 0.30. Your CFO's role demands him to maximize the value of the firm. Your CFO asked you that is there an easily identifiable debt-equity ratio that will maximize the value of a firm? Why or why not? He gave you a couple of days to answer this question. You need to support your answers with examples.

Step 1

The firm’s value depends on the discount rate and future cash flows. Weighted average cost of capital is the combined average of cost of debt, cost of equity and cost of preference stock.

Step 2

Cost of debt is considered less as compared to the cost of equity. The lesser the cost, the greater the value of the firm.

Step 3

The value of the firm can be maximized if an appropriate capital structure is used. The optimal capital structure can be achieved by boosting up the leverage. The leverage can be increased by increasing the debt-equity ratio. But more debt means more risk which ...

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