Which of the following factors is least applicable when an analyst is attempting to assess whether a firm’s capital structure is value maximizing? A) The quality of the firm’s corporate governance. B) The proximity of the current structure to the stated target. C) Changes in the structure over time. Your answer: B was correct! Even if the current structure is consistent with the firm’s stated target capital structure, this does not ensure that it is value maximizing. The other items listed can provide useful information regarding whether the firm’s existing capital structure is optimal. (Study Session 8, LOS 28.i) ---- Can someone help to understand their rationale why B is not the right answer? Page 233 Book 2 Schweser says “Management’s use of a target capital structure reflects the knowledge that the firm has an optimal capital structure. For managers trying to maximize the value of the firm, the target capital structure will be the same as the optimal capital structure.” So I thought target = optimal. Is their reasoning simply that the value optimizing capital structure at any point in time may be something other than the target (for example if management is trying to exploit certain opportunities or if there are market value fluctuations) and thus the proximity of the current to target may be irrelvant, as something other than the target may be what optimizes firm value at that point in time?
Did this question earlier. Found choice A kind of suspect, thought it was correct, but whatever. Optimal may not equal Target, because as you said, certain exploitations of market anomalies may push it away from the target temporarily.
so are we to assume that unless told otherwise target structure = optimal structure? and in certain cases mgmt shifts from target to a diff structure which may at that time maximize the value of the firm (i.e. this new optimal structure is different than the target structure)
It seems like B is correct because the target capital structure may not be the optimal capital structure. Let’s say management believes 95% debt and 5% equity is the optimal capital structure for various reasons. However, in reality, a 60/40 mix would be optimal in order to maximize value. If the current mix is 90/10, would that maximize value since it is close to the target? Probably not.
If 95 and 5 is the optimal then I would think that 90 and 10 would maximize value more than 60 and 40 since 90 and 10 is closest to the optimal of 95 and 5. My understanding is simply that 95 and 5 should not always be strictly looked at because there may be other factors at apply at the current time which could make 60 and 40 (further away from target) to be more optimal at that time.
Terrible question… There are so many things wrong with it…
It is safe to assume target capital structure = optimal structure, letting go the silliness of the question.
The other options should not confuse once we assume optimal structure.