Optimal capital structure is a capital structure where the cost of capital is at its lowest. The capital structure is a combination of debt and equity financing. Debt has interest payments attached to it whereas the equity holders require a rate of return to compensate the default risk due to increased debt.
There are various theories that advocate an optimal capital structure. One theory is called the Modigliani and Miller theory with tax implications. MM states that the optimum capital structure is 99.99% debt and 0.001% equity. This is because the higher debt will offer maximum tax savings on higher interest payments to compensate for the overall cost of capital. But in reality, this is not possible and capital structure may differ from industry to industry based on the benchmarks of the companies.
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