【正文】 based on the variety of measures presented in this paper.Originality/value :Topics discussed in this paper have been in development since the 1950s. The contribution of this paper is the creation of a framework for understanding and applying these topics, for pedagogical and management training purposes.Keywords :Capital structure, Corporate finances, Leverage1. IntroductionCapital structure decisions rely on a plex array of theoretical foundations and practical considerations. At the managerial level, it is impractical to base decisions purely on theory. While one can develop a perception of an optimal capital structure, the decision is often obscured by practical limitations to the theoretical base. In order to be useful to practicing managers, policies and decision techniques need to be efficiently acplished and based on available information. This paper provides that practical framework. We recount a simplified theoretical base for capital structure, highlight some of the problems encountered when applying the theory to reality, and suggest a framework for practical managerial decisions about capital structure.The current issue and full text archive of this journal is available at This exposition is especially useful in undergraduate business curricula, in particular for finance majors considering professional management as a career.2. Traditional capital structure theoryCapital structure theory was initially formed in a series of articles by Modigliani and Miller (1958, 1963). Under conditions identified by a long list of simplifying assumptions, they provided the foundation for an understanding of the differences between unlevered and levered firm values. Although many of the assumptions were unrealistic, the initial model served as a point of deviation as assumptions were relaxed. Most of the assumptions involved either tax structure or risk structure simplifications.The typical capital structure theory exposition has bee known since that time as a tradeoff theory. Tradeoff theory provides an exposition of the benefits of prudent debt use and the dangers of excessive debt use. The solution variable is the proportion of debt in the firm capital structure, the debt ratio. Although the model has a high level of mathematical sophistication and plexity, a simplified result can be formed by observing two of the main features of the model.The first feature to consider is that, since interest expense is tax deductible, then the more debt used by the firm, the more wealth created via lower tax payments. This is called a tax shield, which has an evident cash value to shareholders, a ready and apparent gain to leverage. As a firm uses more and more debt, the tax shield will bee larger and larger, adding value to the firm. Graphically, this is shown in Figure 1. Figure 1 shows that the initial value of the firm is the value of the equity, since at zero debt, the firm is financed totally by equity. As debt is added to the capital structure (the debt ratio increases), the value of the firm rises proportionally because of the tax shelter benefit. In the graph, this is represented by the green upward sloping line.The second feature is that risk increases as the firm adds debt to the capital structure. Debt would be very beneficial at low levels, since it is so much cheaper and provides the tax shield. But as large proportions of debt are taken on, the firm begins to be financially distressed by trying to meet interest payment obligations. The more debt the firm adds,FirmvalueValue of debttax shelterFinancial distresscostsDebt ratiothe more financially distressed it bees, less able to service interest expenses for extreme debt levels. Financial distress costs would include higher required returns from both creditors and shareholders, as well as costs directly involved with avoiding bankruptcy and costs associated with financial distress and bankruptcy. These costs, at some point, begin to offset the positive effects of the tax shield, and the value of the firm begins to level off, and then to decline. This is represented in the graph by the red line. Recognizing just two of the characteristics of debt use (tax shelter and financial distress), the idea of the capital structure decision begins to take shape.The graph seems to suggest that there is some debt level that is optimal ([D/A] *)。 that is, a debt level that will maximize the value of the firm (maximize shareholder wealth). Firms would want to use debt, up to the point where the value of the firm is maximized, the optimal capital structure (optimal debt ratio). This is what we would conclude to be a fully rational capital structure decision. Deviations away from this optimal point will result in a suboptimal capital structure, and the firm would no longer be maximizing shareholder wealth.Obtaining a debt ratio exactly equal to (D/A) * is optimal. Small deviations above and below the optimal proportion of debt, however, result in very little change in the value of the firm. Within a sufficiently small range above and below (D/A) *, the value of the firm can be shown to be fairly constant (Figure 2). Accepting a debt ratio in this range would be a nearrational (not fully optimal) capital structure decision. The idea of maximizing the value of the firm can also be perceived in terms of minimizing the firm抯 weighted average cost of capital (WACC). In capital cost arguments, investors are thought to require the least return when the firm has lowdebt levels, since the firm will be less risky. Also, the cost of debt, for reasons discussed earlier, will be lower than the cost of equity. As the firm begins to add debt to its capital structure, the WACC falls because the firm is using more of the cheaper form of financing, debt. At some point, however, the WACC will begin to rise as both creditors and shareholders begin requiring everincreasing returns as risk rises. TheWACC argument can be perceived graphically as well. At zero debt, the WACC is equal to the cost of equity. At 25 percent debt, the WACC is onefourth of the way between KD and KE. At 50 percent debt, the WACC is halfway between KD and KE.FirmvalueValue of debttax shelterFinancial distresscostsDebt ratioThe resulting WACC curve suggests that a particular D/A ratio will minimize capital costs. This D/A ratio should correspond to the same one that maximizes the value of the firm in Figure 1, shown in Figure 3 above the WACC graph for illustration. Another benefit of using debt in a firm capital structure es from agency theory. Manager the capital structure decision. Jensen and Meckling (1976) argue that managers have an incentive to misuse the firm cash. For example, a manager may.WACCFirmvalueFirmvalueValue of debttax shelterFinancial distresscostsDebt ratioDebt rati