Question

Under what circumstances is capital structure irrelevant? Why?

Answer 1

Capital Structure is irrelevant in following circumstances:

1. In case taxes are not there then capital structure is irrelevant. In case of taxes the firm value increases in case of leverage by the amount equal to Tax rate* Debt. This is because interest is tax deductible.If there is not taxes then capital structure becomes irrelevant.
2. If agency costs or transaction costs are not considered for equity issue and debt issue then capital structure is irrelevant. Since flotation cost of equity is higher. It increases the cost of equity of firm. Debt has less transaction costs