Essay: The use of the debt to equity ratio

Essay: The use of the debt to equity ratio

The use of the debt to equity ratio over several years should help the company take into account when certain payments are due this helps in the solvency of the company. There is a specific debt to equity ratio that will reduce a company’s cost of capital.  This also happens to be the point at which the value of the company will be maximized.

Since the cost of capital curve is fairly shallow a company can deviate from this optimal debt to equity ratio without substantially increasing the cost of capital Michael, (2003).  This creates a range in the bottom part of the curve where the cost of capital is basically the same throughout the range. The moment one gets out of this range the cost of capital steadily increases.

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