Capital Structure

2723 Words6 Pages
bulb-icon

Recommended: Descriptive essay on theories of capital structure

Introduction

The relationship between capital structure and firm value has been discussed frequently in the literature by different researcher accordingly, in both theoretical and empirical studies. It has also been discussed that whether the firm has any optimal capital structure that has been adopted by an individual firm, or whether the proportions of debt usage is completely irrelevant to the individual firm value.

A firm can choose a mix of three modes of financing i.e. issuing shares, borrowing from the market and use of retained earnings. The ratio of this mix of funds purely depends on the firm and known as optimal capital structure of the firm. This leads to the different capital structure theories. These theories explain their point of view about optimal capital structure how an optimal capital structure can increase the value of the firm and its impact on the cost of capital of the firm.

Capital structure refers to the mix of debt and equity used by a firm in financing its assets. The capital structure decision is one of the most important decisions made by financial management. The capital structure decision is at the center of many other decisions in the area of corporate finance. These include dividend policy, project financing, issue of long term securities, financing of mergers and so on. One of the many objectives of a corporate financial manager is to ensure the lower cost of capital and thus maximize the wealth of shareholders. Capital structure is one of the effective tools of management to manage the cost of capital. An optimal capital structure is reached at a point where the cost of the capital is minimum.

Pakistan is a developing country with three stock exchanges, the Karachi Stock Exchange (KSE) bei...

... middle of paper ...

...icult in terms of cost and technical difficulties (Shah and Hijazi 2004). The main sources of debt in Pakistan have been commercial banks, which do not encourage long term loans, with almost no reliance on market based debt until mid 1994 when government moved to remove most of the constraints among. Which one action was to amend company law to permit corporate entities to raise debt directly from the market in the form of TFCs (Term Finance Certificates). So corporate bond market has limited history and is in the process of development. This explains why firms on average in Pakistan have more short term financing than long term financing. Booth et al (1999) also pointed in their study on determinants of capital structure in developing countries including Pakistan that the use of short term financing is higher than long term financing in developing countries.

Show More
Related

  • Bestcare Health Maintenance Organization Net Working Capital

    579 Words  | 2 Pages

    Balance sheet lists assets, liabilities and owner’s equity. The assets listed on the balance sheet are acquired either by debt (liabilities) or equity. “Companies that use more debt than equity to finance assets have a high leverage ratio and an aggressive capital structure. A company that pays for assets with more equity than debt has a low leverage ratio and a conservative capital structure. That said, a high leverage ratio and/or an aggressive capital structure can also lead

    Read More

  • Silicon Valley Medical Financial Analysis

    1403 Words  | 3 Pages

    In SIVMED’s case, based on the definition of WACC, all capital bases should be included in its WACC. These include its common stock, preferred stock, bonds and long-term borrowings. In addition to being able to compute for the costs of capital, the WACC also determines how much interest SIVMED has to pay for all its activities. The value of the firm’s stock, which we want to maximize, depends of the after-tax cash flow. Hence, after-tax values for WACC are also needed. Furthermore, cost of capital is used to determine the cost of each debt, stock or common equity. Being able to analyze these will be essential into deciding what and how new capital should be acquired. Hence, the present marginal costs are ideally more essential than historical costs.

    Read More

  • Tyco Capital Structure Essay

    1287 Words  | 3 Pages

    Based on the Consolidated Statements of Shareholder?s Equity, year ended September 2015, in page 71, as shown in the statement, there are no preferred stocks.

    Read More

  • Star Appliance Case Study

    1773 Words  | 4 Pages

    Based on the optimal capital structure analysis, they should pursue as 70% debt proportion, which will give them the lowest cost of capital at 11.58%. Currently Star has no debt in their capital structure, so these new projects should begin to add debt to the company. However, no matter what debt and equity proportions are chosen for each project, the discount rate of 11.58% should be used, as the capital budgeting decisions should be independ...

    Read More

  • Target Corporation: Report On Long-Term Financing Policy And Capital Structure

    1647 Words  | 4 Pages

    Target Corporation: Report on Long-term Financing Policy and Capital Structure with an Acquisition Analysis Introduction This report will be based on the Target Corporation, and will consist of two sections: 1) long-term financing policy and capital structure, and 2) an acquisition analysis. The first section will include: Target's most recent long-term financing decision; an analysis of the economic, business, and competitive background in which the financing occurred; Target's book value and market value; possible changes that would occur to Target's finance policy and capital structure if it was forced to consider re-organization and bankruptcy strategies; and finally discuss Target's international investment and financing opportunities, as well as foreign exchange risks. The second section will be a report to the board of directors that identifies a synergistic acquisition candidate for Target.

    Read More

  • MCI Case Analysis

    1816 Words  | 4 Pages

    See Exhibit C. CAPITAL STRUCTURE MCI's current capital structure is x% debt and y% equity. Their key ratios are a, b, and c. Comparing to other firms in the utilities industry they appear to be underutilizing (debt/equity). See Exhibit D for more information. Referencing the forecast there is expected to be an x% annual increase in net income which would support an increase in debt/equity and keep ratios within the range of other firms in the industry (see exhibit E)....

    Read More

  • Du Pont de Nemours and Company Case Analysis

    1186 Words  | 3 Pages

    The consistent high spending of capital equipment is the first reason why one would recommend reducing the debt to equity ratio. A company with higher levels of debt is less flexible in being able to adjust to new market demands and conditions that require the company to make new products or respond to competition. Looking at the pecking order of financing, issuing new shares to fund capital investing is the last resort and a company that has high levels of debt, must move to the equity side to avoid the risk of bankruptcy. Defaulting on loans occur when increased costs or bad economic conditions lead the firm to have lower net income than the payments on loans. The risk of defaulting on loans and the direct and indirect cost related to defaulting lead firms to prefer lower levels of debt. The financial distress caused by additional leverage can lead to lower cash flows available to all investors, lower than if the firm was financed by equity only. Additionally, the high debt ratio that Du Pont incurred also led to them dropping from a AAA bond rating to a AA bond Rating. Although the likelihood of not being able to acquire loans would be minimal, there are increased interest costs with having a lower bond rating. The lower bond rating signals to investors that the firm is more likely to default than if it had a higher (AAA) bond rating.

    Read More

  • Critically assess the Pecking Order Theory of Capital Structure

    1779 Words  | 4 Pages

    There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than external financing which is due to adverse selection, asymmetry of information, and agency costs (Frank & Goyal, 2003). The trade-off theory comes from the pecking order theory it is an unintentional outcome of companies following the pecking-order theory. This explains that firms strive to achieve an optimal capital structure by using a mixture debt and equity known to act as an advantage leverage. Modigliani and Miller (1958) showed that the decisions firms make when choosing between debt and equity financing has no material effects on the value of the firm or on the cost or availability of capital. They assumed perfect and frictionless capital markets, in which financial innovation would quickly extinguish any deviation from their predicted equilibrium.

    Read More

  • UST Case Solution

    1327 Words  | 3 Pages

    Higher leverage is very likely to create value for a firm considering capital structure change by exerting financial discipline and more efficient corporate strategy changes.

    Read More

  • Home Depot & Capital Structure

    987 Words  | 2 Pages

    Finding the perfect capital structure in terms of risk and reward can ensure a company meets shareholder expectations and protects a firm in times of recession. Capital structure refers to how a business puts its money to “work”. The two forms of capital structure are equity capital and debt capital. Both have their benefits and limitations. Striking that perfect balance between the two can mean the difference between thriving versus trying to survive.

    Read More

  • Saudi Arabia Capital Market Case Study

    1215 Words  | 3 Pages

    In 2003, Capital Market Authority (CMA) was established under the Capital Market Law (CML) to act as regulatory supervisor for the capital market. Capital Market Authority regulate and supervise different critical issues such as market conduct, merger and acquisitions, corporate governance, and issuance of financial tools such as mutual funds, IPOs and Sukuks “Islamic bonds”. Thus, the establishment of CMA defined a new stage of financial liberalization in the country. CMA established the legal and regulatory platform to open up the Saudi capital market, support the privatization effort and increase public participation in the market while promoting efficiency and transparency. Furthermore, in March 2007, Tadawul exchange was re-incorporated as joint stock Company with a capital of USD 320 million to increase autonomy for the exchange. After the formation of CMA, the Saudi capital market continuously evolving in term of breadth, depth and complexity. In March 2010, the number of listed companies increased to 139 from 76 back in 2001 as local companies started to look at capital markets to fund their future financing needs. Due to the increasing in investors participation, Tadawul’s total market capitalization at a compound annual growth rate “CAGR” of 34.8% to SAR 1.9 trillion which about USD 507 billion between 2003-2007. Due to the financial crisis in 2008-2009 the market capitalization for Tadawul declined to SAR 1.2 trillion, which about USD 320 billion. Between the years of 2003-2007, the stock market activity grew in a fast pace without interruption in term of value, volume, and market cap along with rising in the number of transactions. The total trading volume of shares on Tadawul Stock Exchange increased at a CAGR of 11.4% between 2003-2009. The

    Read More

  • Summary Of Target Corporation Capital Structure

    1753 Words  | 4 Pages

    The capital structure decisions for Target Inc. are significant since the profitability of the firm is specifically influenced by this decision. Profit maximization is part of the wealth creation process and wealth maximization can be a lengthy process for financial managers. Profits affect the value of the firm and it is expressed in the value of stock. Cost of capital is how investors evaluate weighted average cost of capital (WACC). Capital structure ratios help investors gauge the level of risk that a company is taking on through financing. While Target

    Read More

  • The Purpose of Financial Statements

    1286 Words  | 3 Pages

    Ÿ Capital structure/investment - This information is taking from the Balance sheet, but also from the Profit and Loss Account. This is examining the sources of finance the company has used and also looking at it as a potential investment opportunity. There are certain features, which must be present if financial information is to meet the needs of the user. The two most important features are that: Ÿ The information should be relevant to those who are using it.

    Read More

  • Advantages And Disadvantages Of Capital Structure

    1186 Words  | 3 Pages

    The capital structure of a firm is the way in which it decides to finance its operations from various funds, comprising debt, such as bonds and outstanding loans, and equity, including stock and retained earnings. In the long term, firms seek to find the optimal debt-equity ratio. This essay will explore the advantages and disadvantages of different capital structure mixes, and consider whether this has any relevance to firm value in theory and in reality.

    Read More

  • Company's Cost of Capital

    1176 Words  | 3 Pages

    During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis’s cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task.

    Read More

More about Capital Structure

Open Document