Contents :
Introduction on Capital Structure
Summary and Evaluation of Articles
Conclusion
References/Bibliography
Introduction On Capital Structure :-
In the field of finance capital structure means a way an organization or firms finances their assets by the way of some mix and match of Equity, Debt or Hybrid Securities.
The modern thinking on capital structure is based on the Modigliani-Miller theorem given by Franco Modigliani and Merton Miller. The theorem suggests that in a perfect market the total value of the company remains the same depending upon how is that company financed. This theorem proves the importance of capital structuring by the firms throughout the globe. There are other reasons as well like bankruptcy costs, agency costs and asymmetric information. Also this paper has tried to explain the trade off theory and it also talks about the firm-specific and country-specific factors of capital structure.
Articles Relating to Capital Structure :-
There have been lots and lots of study, researches, arguments, and articles written on capital structures as it is one of the wide topics to discuss upon.
For an Example, If a company sells £40bn pounds in equity and £60bn pounds as debt then the company is said to be having a capital structure with 40% equity finance and 60% debt finance. And the company’s Leverage Ratio which is given by dividing total debt to total financing i.e. 60% in this example.
Starting with a very informative article in which the writers have tried to analyze the importance of firm-specific and country-specific factors in the leverage choices of 42 different countries around the world. Past researches by [Demirgüç-Kunt and Maksimovic, 1999], [Booth et al., 2001], [Claessens, ...
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...re around the world: The roles of firm-specific and country-specific determinants’, Journal of Banking and Finance, Vol.32, No. 9, pp. 1954-1969. [WWW] Available from-
[Accessed at 9th December, 2008].
Joyce, W. (2000) ‘Capital Structure and Financial Stress’, Credit and Financial Review, Second Quarter. [WWW] Available from- [Accessed at 9th December, 2008].
Miller, M. (1977) ‘Debt and Taxes’, Journal of Finance, Vol.32, pp. 261-276.
Modigliani, F. and Miller, M. (1963) ‘Corporate Income Taxes and the Cost of Capital: A Correction’, American Economic Review, Vol.53, pp. 433-443.
Rajan, R. and Zingales, L. (1995) ‘What do we know about capital structure? Some evidence from international data’, Journal of Finance, Vol.50, pp. 1421–1460.
Telser, L. (1966) ‘Cutthroat competition and the long purse’, Journal of Law and Economics, Vol.9, pp. 259–277.
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
in business it need to be consider the most effective form. Capital is one of the factors to
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.
While taking into account the mix of the debt / equity that maximizes the price of the common stock, I assume that the optimal capital structure would be 70% equity and 30% debt.
Does the capital structure of a firm really matter? If so, how and why does it matter? Practitioners and scholars of corporate finance have debated these questions for several years and have found it difficult to come up with definitive answers. The classical work of Modigliani and Miller (1958) provided the impetus for what is now, orthodox corporate finance theory on the optimal capital structure of firms. They postulated that, in a perfect or frictionless capital market, the choice between debt and equity financing has no material effect on the value of the firm. Stern and Chew (2003) noted that following the Modigliani-Miller propositions, academic researchers in the 1960s and 1970s turned their attention to market imperfections that might make firm value depend on capital structure. They further noted that the main suspects were a tax code that encourages debt by making interest payments but not dividends tax-deductible and expected costs of financial distress that rise with increasing amount of debt. Towards the end of the 1970s, they noted, there was also discussion of signalling effects, such as the tendency for stock prices to fall significantly on the announcement of new equity issues and to rise on the news of stock buyouts. These effects seemed to confirm the existence of large information cost that could influence financing choices in the predictable ways.Myers (1984), however, noted that there is a conflict which has existed among the different theories and referred to is as the “capital structure puzzle.” Barclay and Smith (2005) noted that it has been the difficulty of coming up with conclusive tests of the competing theories. Firstly, they noted that model on capital structure typically are less precise than...
Assessing the capital structure of any firm is important for investors attempting to determine if...
Capital structure is the composition of the company 's capital value and the proportion of the relationship which can reflect the company 's structural stratification and core competitiveness of the company 's business performance also has unpredictable impact on market value, shareholder wealth and even sustainable development capacity . Through the analysis of the equity ratio, the debt ratio, the long-term debt ratio, the return on assets and the Modigliani and Miller theory, Sainsbury 's capital structure is stable.
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.
The market value is not affected by the firm’s capital structure, that’s what the M&M first proposition stated; in proposition one it is stated that under certain conditions the firm’s debt equity has got no effect on the firm’s market value. This approach is based on the below:
This week the class read about capital structure. Capital planning is the procedure used to figure out if a company’s log-term investments merit seeking after. A major consideration in capital budgeting decision is the risk. The company needs to differentiate the assumed return from the venture with the uncertainty connected with it. The bigger the risk attempted, the increased return, the smaller the risk, and the smaller the return. At the point when the company, settles on capital budgeting choice, they wish at a minimum to recuperate enough to pay the expansion expanded by the venture. The article I came across with is a great example of capital structure, “How Will The Virgin America Deal Alter Alaska Air’s Capital Structure?”
The sources of this capital may either be internal (contribution from shareholders in the form of equity; ploughed back revenue et cetera); or they could external (borrowing from banks; private equity firms; development finance institutions; capital markets et cetera).
The use of fixed charge capital is known as financial leverage. If there is no fixed charge capital, there is no financial leverage. The proper utilization of fixed charged capital like debentures, bonds, bank loan and preference share capital is measured by financial leverage. The firm having more debt capital and preference share capital in its capital structure has higher degree of financial leverage and greater amount of risk.
According to Howe and Shilling (1988), REITs is required to have a 100% equity capital structure if there is absence of tax deductibilty. It means it will be too expensive to issue debt and they will be at a economical disadvantage if REITs have to compete for debt funds against non-REIT firms that receive the tax benefit of debt. However, Jaffe (1991) disagree with this statement. He shows that for REITs, capital structure irrelevance does indeed hold, theoretically following the original Modigliani and Miller (1958) irrelevant proposition.
Capital restructuring refers to the rearrangements of capital assets in order to position the business so that the company is able to take advantage of a growth opportunity or the mix between different classes of debts and equity. Capital restructuring usually is adopted by companies that are going bankrupt as through capital restructuring it will help enhance the core functions and aspect of a business making it more attractive to potential investors to help save the company from bankruptcy.
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.