Your firm has an optimal capital structure that has been identified as 50% debt and 50% equity.
Despite this, your firm’s executives have decided to operate for the foreseeable future with a capital
structure of 30% debt and 70% equity. Briefly discuss the effect this might have on the firm’s cost of
equity (it has been calculated that it would have been 12% if the firm were operating at its optimal
capital structure). Furthermore, discuss how this decision is likely to affect shareholder wealth.

Sample Solution