Final answer:
The true statement about optimal capital structure is that it minimizes financial risk. Very small companies raise capital from private investors due to the high costs of IPOs. Venture capitalists usually have better information about small firms than potential bondholders.
Step-by-step explanation:
The optimal capital structure is the proportion of debt, equity, and other types of financing that a firm uses to fund its operations and growth which balances the benefits and costs, resulting in the lowest possible weighted average cost of capital (WACC) for the firm. The correct statement about optimal capital structure is A: Optimal capital structure minimizes financial risk. Understanding this involves recognizing that it preserves the balance between maximizing company value and minimizing its cost of capital.
Addressing the self-check questions about early-stage corporate finance:
- Very small companies tend to raise money from private investors rather than through an IPO due to the costs and regulations associated with going public which can be prohibitive for such companies.
- Small, young companies may prefer an IPO because it allows them to raise large amounts of capital without the obligation of regular interest payments as is the case with bonds or loans, offering more flexibility for growth.
- Venture capitalists typically have better information about whether a small firm is likely to earn profits compared to a potential bondholder because they are often more closely involved in the management and operation of the company.
Regarding how a bond is similar to and different from a bank loan:
Calculating equity in the home example:
Fred's equity in his house is the down payment he made which is 10% of the $200,000 purchase price, equal to $20,000.