The optimal capital structure maximizes the stock price but not EPS. What’s the logic behind it? Thanks
EPS = Earnings Per Share.
you cannot control
a) the number of shares a company has (Denominator)
b) the earnings that the company can expect to earn (the numerator)
however with the capital structure - right mix of equity and debt - and the impact of taxes, you can decide how you can affect the share price of the company.
first stab at this … and have done Level 2 a very long time ago … so others please feel free to chime in
Maybe you can lever the company to the hilt to maximize EPS, but the extra risk will be priced into the stock lowering its value.
EPS is based on an accounting figure. The stock price should represent the PV of all expected future cashflows based on ownership in the firm. Accounting numbers aren’t what people want to pay for (think of a firm with great accounting profits, but terrible (expected) cashflows-- who would want to pay for shares of stock?). People want to pay for (expected) cash. Optimal capital structure will balance the benefits of debt with it’s risk/costs in a way that creates the highest present value of the expected cashflows to owners of the firm (stock price).
Hope this helps.
Thanks all