Capital of a firm is a mix (or proportion) of a firm permanent long term financing representing by debt, preferred stock and common stock Given that is firm has a certain structure of assets, which offers net operating earnings of given size and quality, and given a certain structure of rates in the capital markets in there some specific degree financing leverage at which the market value of firm’s securities will higher (or the cost of capital will be lower) than at other degrees of leverage? This question has been the basis of extensive work on capital structure and has resulted in a number of theories which we shall now focus on.
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