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.

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Asked Oct 31, 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.

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Expert Answer

Step 1

The company has the option of financing either through debt or equity. Cost of debt is usually lower than the cost of equity and this is the reason why firms prefer debt financing over equity. Moreover, interests on debt are tax exempted which further lowers the cost of debt.

Step 2

The best way to maximize a company’s value is to lower its weighted average cost of capital(wacc). Thus, leveraging plays an important role. However, after a point even if the debt in the company is increased the wacc increases. This is primarily because if a company is he...

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