Slide MGT411 Slide13

Chapter 16
Sourcing Debt
Globally

Copyright © 2007 Pearson Addison-Wesley. All rights reserved.

Optimal Financial Structure
• The domestic theory of optimal financial structure must be
modified considerably to encompass the multinational firm.
• Most finance theorists are now in agreement about whether an
optimal financial structure exists for a firm, and if so, how it can be
determined.
• When taxes and bankruptcy costs are considered, a firm has an
optimal financial structure determined by that particular mix of
debt and equity that minimizes the firm’s cost of capital for a given
level of business risk.
• As the business risk of new projects differs from the risk of existing
projects, the optimal mix of debt and equity would change to
recognize tradeoffs between business and financial risks.

Copyright © 2007 Pearson Addison-Wesley. All rights reserved.

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Optimal Financial Structure
• The following exhibit illustrates how the
cost of capital varies with the amount of
debt employed.
• As the debt ratio increases, the overall
cost of capital (kWACC) decreases because
of the heavier weight of low-cost (due to
tax-deductibility) debt ([kd(1-t)]
compared to high cost equity (ke).
Copyright © 2007 Pearson Addison-Wesley. All rights reserved.

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