During the last two decades Small and medium size enterprises have played an increasingly important role for economies worldwide and continues to be an important tool for economies especially for the growth of developing countries. The main challenge faced is the level of credit risk. The goal for a bank is to maximize the risk - adjusted rate of return; hence managing credit risk is essential for long term profitability and lending. Loans (credits) are the most common credit risk that banks need to manage (Basel Committee on Banking Supervision, 2000). In this paper, credit risk will refer to the risk banks become exposed to when they lend money to companies, in our case small and medium size firms
1.3. Sources of financing
The survival of every business depends on its ability to raise funds for its operations. Every business needs capital at least to: start up, grow, thrive, expand, compete and survive. Where do firms obtain the cash they need to finance their operations? Broadly speaking, firms generate cash through their operations. They also raise money through borrowings from lending institutions often referred to as debt financing and through selling part of their ownership referred to as equity financing.
As economies continues to face credit challenges, due to financial crisis, small businesses, especially new, small and medium size companies find it even more difficult to locate the financing they need to take their ideas and concepts and turn them into viable businesses. Although Small and Medium Size Enterprises in developing countries are a potential starting point for any enduring industrialisation that contributes to long run growth, producing and increasing the number of firms that grow up and out of the small sect...
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... Jaime F. Zender (2010). Debt Capacity and Tests of Capital Structure Theories. Journal of Finance and quantitative analysis, 45, pp 1161-1187. doi:10.1017/S0022109010000499.
H. DeAngelo and R. Masulis. “Optimal Capital Structure under Corporate and Personal Taxation.” Journal of Financial Economics 8 (March 1980), 3–29. CrossRef, Web of Science® Times Cited: 335
Bryman, A (2006) Integrating quantitative and qualitative research: How is it done? Qualitative research, Vol.6 No. 1, pp. 97 – 113
Sheridan Titman and Roberto Wessels (2012) The Determinants of Capital Structure Choice, The journal of finance, 30 APR 2012, DOI: 10.1111/j.1540-6261.1988.tb02585.x
Satish Raj Pathak (2011
Fakher Buferna Kenbata Bangassa and Lynn Hodgkinson.(2005) Determinants of capitall structure: Evidence from Lybia, The University of Liverpool, Research paper. No. 2005/08. ISSN 1744-0
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.
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...
The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, the value of a firm is unaffected by how that firm is financed. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs. These other reasons include bankruptcy costs, agency costs and asymmetric information. This analysis can then be extended to look at whether there is in fact an 'optimal' capital structure: the one which maximizes the value of the firm.
The results obtained from the cooperation of Modigliani and Miller in 1958, was an attempt to prove that the financial decisions should not be significant in the perfect conditions of the market, after being published the Modigliani and Miller theory became the main theory of the capital structure.
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?”
When starting a business an important question arises, how to finance the company. The steady economic growth combined with low interest rates has produced a lot of liquidity in debt and equity markets. For example, in 2005, non-financial corporate business borrowing increased dramatically to $289 billion, compared to the mere $174 billion it was in 2004 and the $85 billion it was in 2003 (Chung). The outcome of using only debt financing or only equity financing is mostly direct. Businesses run ino the issue when a company’s finance requires both debt and equity characteristics, changing the tax effects greatly (Hanke).
Shah & Khan. (2007). Determinants of Capital Structure: Evidence from Pakistani Panel Data. International Review of Business Research Papers , vol. 03 (no. 04), p. 265-282.
What is capital structure? Capital structure describes the specific mixture of long-term debt and equity the firm uses to finance its operation and growth. The risk and value of the firm will be affected by this mixture. Hence, it is often a challenging task for the finance managers to determine the optimal capital structure. An error free decision is critical to avoid an incorrect financing decision (Eriotis, Vasilou & Neokosmidi, 2007) and different levels of debt and equity used in capital structure suggest that managers may employ firm-specific strategies for improved performance (Gleason, Mathur, & Mathur, 2000).
Modigliania, F., & Miller, M. H. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. The American Economic Review.
The greater part of finance demand from these enterprises is in the form of debt, estimated at about INR 26 trillion. Overall demand for equity in the SME sector is INR 6.5 trillion, which makes up 20 percent of the total demand. The sector has high leverage ratios with average debt-equity ratio of 4:1. But these leverage ratios are not even across the sector and variations exist based on the size of the enterprise. For instance medium-scale enterprises exhibit a more balanced debt-equity ratio of 2:1. The unregistered enterprises, which comprise 94 percent of the SME sector, account for INR 30 trillion of the finance demand. This demand estimate does not take into account the demand for finance by unorganized
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.
The choice of appropriate source of fund for capital structure is one of the major policy decisions taken by a firm.(Kumar, Anjum & Nayyar,2012) The
Thus, capital structure would vary from one company to another company depend upon the company’s availability of fund, operational size, from different sources and management efficiency etc.
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.