What is Optimal Capital Structure?
Optimal capital structure is the mix of debt and equity that minimizes a company’s weighted average cost of capital (WACC) and maximizes its value, given its business risk and tax position.
How It Works
- Estimate cost of debt (after-tax) and cost of equity.
- Find the leverage point where WACC is lowest.
- Balance benefits of debt (tax shield) against distress costs.
Saudi Context
Saudi listed companies often run at conservative leverage given Zakat-based taxation (limited interest tax shield for Zakat-only entities) and SAMA-imposed limits on bank exposure.
Example
A Saudi industrial firm finds WACC is lowest at 35% debt to total capital and adjusts financing to that target over time.