Chapter 32
CAPITAL STRUCTURE POLICIES : Capital structure and the theory of perfect capital markets

Is there such a thing as an optimal capital structure, i.e. a way of splitting the financing of operating assets between debt and equity which would enhance the value of the operating assets and minimise the company's cost of capital? This is the central question that this chapter attempts to answer.

The real-world camp says yes, but without being able to prove it, or to set an ideal level of net debt and equity.

Modigliani and Miller said no in 1958, and showed how, if it were so, there would be arbitrages that re-established the balance.

For an investor with a perfectly diversified portfolio, and in a tax-free universe, there is no optimal capital structure. The following rules can be formed on the basis of the above:

But a world without taxes is a utopia, which is why the next chapter brings tax and other “distortions” into the equation.