What is an 'Optimal Capital Structure'
An optimal capital structure is the best debttoequity ratio for a firm that maximizes its value. The optimal capital structure for a company is one that offers a balance between the ideal debttoequity range and minimizes the firm's cost of capital. In theory, debt financing generally offers the lowest cost of capital due to its tax deductibility; however, it is rarely the optimal structure since a company's risk generally increases as debt increases.
BREAKING DOWN 'Optimal Capital Structure'
A company's ratio of short and longterm debt should also be considered when examining its capital structure. Capital structure is most often referred to as a firm's debttoequity ratio, which provides insight into how risky a company is for potential investors. Determining an optimal capital structure is a chief requirement of any firm's corporate finance department.
Companies can raise capital with either debt or equity. Each strategy has its own advantages and disadvantages. Debt usually costs less than equity due to tax advantages, especially when rates are low. However, debt also obligates the company to pay out a portion of future earnings, even when earnings are declining. By contrast, equity does not need to be paid back; however, equity comes with an exchange of ownership. Most companies use a mix of both debt and equity to raise capital. This mix is referred to as the capital structure. It is the goal of most public companies to operate at an optimal capital structure to maximize profits.
Optimal Capital Structure
There are two ways to think about optimal capital structure. One is personal and one is businessrelated. A chief executive officer (CEO) may not like debt in her personal life; however, her company may require the use of debt to maximize profits. At some point the debt becomes a strain on earnings. Qualitatively, the optimal capital structure lies somewhere between maximum profitability and financial burden.
Quantifying Optimal Capital Structure
The most popular way analysts measure capital structure is with the debttoequity ratio. Some analysts compare it against other companies in the same industry. The assumption is these companies are operating at an optimal capital structure, which is a significant assumption. In this case, an analyst can select a few of the bestperforming or highgrowth companies in the industry for comparison. The assumption holds but is less significant.
Another way to determine optimal debttoequity levels is to think like a bank. What is the optimal level of debt a bank is willing to lend? An analyst may also utilize other debt ratios to put the company into a credit profile using a bond rating. The default spread attached to the bond rating can then be used for the spread above the riskfree rate of a AAArated company.

Capital Structure
A mix of a company's longterm debt, specific shortterm debt, ... 
Traditional Theory Of Capital Structure
The theory that when the Weighted Average Cost of Capital (WACC) ... 
Capitalization Structure
The proportion of debt and equity in the capital configuration ... 
LongTerm Debt To Capitalization ...
A ratio showing the financial leverage of a firm, calculated ... 
Capitalization Ratios
Indicators that measure the proportion of debt in a companyâ€™s ... 
Cost Of Capital
The required return necessary to make a capital budgeting project, ...

Investing
Breaking Down Optimal Capital Structure
An optimal capital structure shows the best balance of debt to equity a company can have in order to minimize its cost of capital. 
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Target Corp: WACC Analysis (TGT)
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Capital Structure
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The Optimal Use Of Financial Leverage In A Corporate Capital Structure
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Learn to use the composition of debt and equity to evaluate balance sheet strength. 
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Financial Leverage In Corporate Capital Structure
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Investing
Explaining Cost Of Capital
Cost of capital is the cost of funds used to finance a business. 
Markets
McDonald's Stock: Capital Structure Analysis (MCD)
Learn about the importance of capital structure, and what equity and debt capitalization measures can tell us about the performance of McDonald's Corporation.

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