Method for Assessing Capital Structure

Based on the trade-off theory, this dissertation proposes a formula for evaluating capital structure by linking several factors: EPS * D/C ratio * Tax rate = Price * (Required rate of return for a leveraged firm - Required rate of return for an unleveraged firm) When tax benefits (left-hand side of the formula) exceed the costs of financial distress (right-hand side), the company is under-leveraged; conversely, the company is over-leveraged. Indeed, the company achieves the optimal capital structure if and only if this formula is balanced. The empirical study was conducted among the largest European companies using this valuation model. The results show that large European companies are over-leveraged. Furthermore, this trend increased during the period 2000-2007.