The traditional approach to company gearing and the WACC
The traditional theory of optimal capital structure assumes that there is an optimal debt-equity ratio (and thus an optimal capital structure) for every company. The optimal level of gearing describes a situation with minimal financial cost.
Thereby specific behaviours of the investors are assumed. For a given total capital a company is able to minimize the average cost of capital by substituting more expensive equity through cheaper debt. By doing this the average cost of capital and thus the market value of the entire company is maximized. This is also called earned value concept
The advantage of the continuous exchange of equity with debt decreases with increasing gearing despite of constant demanded premiums from the lenders, because the equity investors recognize the increased risk and thus demand higher risk premiums.
At a certain level of gearing even the debt lenders recognize the increased risk and demand higher interest rates on debt. The average cost of capital can not be reduced anymore by a further capital restructuring.

The traditional approach :

Arguments in favor of the traditional approach The arguments are mainly based on assumptions about the behavior of Investors (behavioral assumptions).
The main questions are:
° How do investors perceive risk?
° How do investors adjust their demanded interests or risk premiums if the financial risk of the investment changes?
As long as one only argues with the behavior, the traditional theory of the existence of an optimal capital structure seems to be superior.

Modigliani and Millers theses
The market value of a company is independent from its capital structure. It is calculated by discounting the expected future profits of the enterprise with the required return on equity of a fully equity financed company of the same risk class.