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Market Value
www.sciedu.ca/ijfr

International Journal of Financial Research

Vol. 3, No. 4; 2012

Market Value of the Firm, Market Value of Equity, Return Rate on Capital and the Optimal Capital Structure
Chao Chiung Ting Michigan State University, USA E-mail: tingtch7ti@aol.com Received: September 4, 2012 doi:10.5430/ijfr.v3n4p1 Abstract The firm should pursue both maximum return rate on capital and maximum return rate on equity simultaneously. Maximum return rate on capital is the primary goal for firms because maximum return rate on capital guarantees efficiency. Therefore, maximum profit, maximum market value of the firm, maximum value of equity and maximum return rate on equity are inappropriate to be the primary goal. Since gross profit is independent of capital structure, capital structure just distributes return on capital into equity and debt (i.e., maximum return rate on equity determines capital structure). The maximum return rate on equity is the secondary goal that the firm pursues. Leverage makes the return rate on equity be higher than interest rate. Leverage explains the puzzle of equity premium. Keywords: Maximum profit, Maximum value of the firm, Capital structure, Equity premium 1. Introduction What is the primary goal for a business? There are many answers for this question. For examples, maximum profit, maximum market value of the firm, maximum market value of equity, maximum return rate on equity, optimal capital structure and …etc. Microeconomics takes maximum profit as an axiom to allocate resource while finance applies value maximization to be a fundamental principle for business performance evaluation. It is no doubt that both microeconomics and finance intend to investigate the same object as firms. Why do they use different goals to study firms? The answer is: economists usually advocate new hypothesis (e.g., natural rate of unemployment) to solve economic puzzles and financial expert are accustomed to introduce new criteria to analyze


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