Examine capital structures of guideline companies,.Identifying the optimal structure is a combination of art and science. So, the optimal capital structure comprises a sufficient level of debt to maximize investor returns without incurring excessive risk. When debt reaches this point, investors may demand higher returns as compensation for taking on greater risk, which has a negative impact on business value. But at a certain level of debt, the risks associated with higher leverage begin to outweigh the financial advantages. If risk weren’t a factor, then the more debt a business has, the greater its value would be. So, as the level of debt increases, returns to equity owners also increase - enhancing the company’s value. Debt is often cheaper than equity, and interest payments are tax-deductible. Many business owners strive to be debt-free, but a reasonable amount of debt can provide some financial benefits. WACC is a company’s average cost of equity and debt, weighted according to the relative proportion of each in the company’s capital structure. When valuing invested capital - that is, the sum of debt and equity in an enterprise - the weighted average cost of capital (WACC) is used as the cost of capital. That rate, also known as the cost of capital, generally reflects the return that a hypothetical investor would require. Generally, when valuators use income-based valuation methods - such as discounted cash flow - they convert projected cash flows or other economic benefits to present value by applying a present value discount rate. Capital structure matters because it influences the cost of capital.
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