Capital structure management

Definition of Capital Structure: Capital structure substitution theory[ edit ] The capital structure substitution theory is based on the hypothesis that company management may manipulate capital structure such that earnings per share EPS are maximized.

In case of companies, it is financed from various sources. In the real world[ edit ] If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance.

Obviously, more of the former means less equity and, therefore, indicates a more leveraged position. It is made up of debt and equity securities and refers to permanent financing of a firm. This section does not cite any sources. Equity is more expensive than debt, especially when interest rates are low.

It denotes some degree of permanency as it excludes short-term sources of financing. Modigliani and Miller made two findings under these conditions.

Thus, the form of debt a firm chooses can act as a signal of its need for external finance. Their first 'proposition' was that the value of a company is independent of its capital structure. In one company debt capital may be nil while in another such capital may even be greater than the owned capital.

Since the sales of a retail apparel company are driven primarily by trends in the fashion industry, the business risk of a retail apparel company is much higher.

From the investor's perspective, the greater the percentage of funded debt to total debt, the better. In proprietary concerns, usually, the capital employed, is wholly contributed by its owners.

Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value. However, unlike debt, equity does not need to be paid back if earnings decline. Equity Shares and Debentures i.

As debt-to-equity ratio increases, management has an incentive to undertake risky, even negative Net present value NPV projects.

Increasing leverage imposes financial discipline on management. This contradicts Hamada who used the work of Modigliani and Miller to derive a positive relationship between these two variables. Investors should understand that there is a difference between operational and debt liabilities - it is the latter that forms the debt component of a company's capitalization.

It states that there is an advantage to financing with debt, namely, the tax benefits of debt and that there is a cost of financing with debt the bankruptcy costs and the financial distress costs of debt.

In the words of P. Please help improve this section by adding citations to reliable sources. Equity Shares and Debentures i.

A new company cannot collect sufficient funds as per their requirements as it has yet to establish its creditworthiness in the market; consequently they have to depend only on equity shares, which is the simple type of capital structure.

It is calculated by dividing debt by equity. That's not the end of the debt story, however. The optimal structure would be to have virtually no equity at all, i. Capital not bearing risk Capital bearing risk includes debentures risk is to pay interest and preference capital risk to pay dividend at fixed rate.

Management Style Management styles range from aggressive to conservative.

Capital structure

The company has less risk in its business given its stable revenue stream. It states that companies prioritize their sources of financing from internal financing to equity according to the law of least effort, or of least resistance, preferring to raise equity as a financing means "of last resort".

Decisions relating to financing the assets of a firm are very crucial in every business and the finance manager is often caught in the dilemma of what the optimum proportion of debt and equity should be. Capital structure is a part of the financial structure and refers to the proportion of the various long-term sources of financing.

It is concerned with making the array of the sources of the funds in a proper man­ner, which is in relative magnitude and proportion. Clarifying Capital Structure-Related Terminology The equity part of the debt-equity relationship is the easiest to define. In a company's capital structure, equity consists of a company's common.

Capital Structure

Refer to overseeing the capital structure as capital structure management. Capital Structure Strategy. Under stable market conditions, a company can compute its. Capital structure can be a mixture of a firm's long-term debt, short-term debt, common equity and preferred equity.

A company's proportion of short- and long-term debt is considered when analyzing. Capital Structure Management 14 April, 1) What is the objective of capital structure management? The objective of capital-structure management can be viewed as the endeavor to find the financing mix that will minimize the firm's composite cost of capital and maximize the value of the stock.

Capital Structure Management A company’s capital structure refers to the combination of its various sources of funding.

Most companies are funded by a mix of debt and equity, including some short-term debt, some long-term debt, a number of shares of common stock, and perhaps shares of .

Capital structure management
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Capital Structure: Concept, Definition and Importance