Why should the mix of debt and equity in a capital structure be optimized?

Optimizing the mix of debt and equity in a capital structure is crucial for maximizing the intrinsic value of the stock. The intrinsic value represents the perceived or true value of a company's stock based on fundamentals, rather than market fluctuations. When a firm effectively balances its use of debt and equity, it can lower its overall cost of capital, thereby increasing the stock's intrinsic value.

Debt usually has a lower cost than equity because interest is tax-deductible, whereas dividends are not. By taking on the right level of debt, a company can leverage its operations to enhance returns on equity, leading to higher valuations. However, it's essential to avoid excessive debt that can increase financial risk, leading to higher costs of capital if investors begin to perceive the firm as risky.

Thus, an optimized capital structure not only improves the returns for shareholders but also aligns with the company's strategic goals, aiming for sustainable growth and stability. This focus on intrinsic value directly correlates with shareholder wealth maximization, as increasing intrinsic value usually reflects positively on the company’s market performance.