A perfectly competitive market is one in which the number of buyers and sellers is very large, all engaged in buying and selling a homogeneous product without any artificial restrictions and possessing perfect knowledge of market at a time. In the words of A. The following are the conditions for the existence of perfect competition: The first condition is that the number of buyers and sellers must be so large that none of them individually is in a position to influence the price and output of the industry as a whole.
It is synonymously used as financial leverage or financing mix. Capital structure is also referred as the degree of debts in the financing or capital of a business firm. Financial leverage is the extent to which a business firm employs borrowed money or debts. In financial managementit is a significant term and an important decision in a business.
In the capital structure of a company, broadly, there are mainly two types of capital i. Out of the two, debt is considered a cheaper source of finance because the interest payments are a tax-deductible expense.
|Determinants of Capital Structure||Usually, a company that is heavily financed by debt has a more aggressive capital structure and therefore poses greater risk to investors.|
|What is 'Capital Structure'||Thus, the chief goal of any corporate finance department should be to find the optimal capital structure that will result in the lowest WACC and the maximum value of the company shareholder wealth. The cost of debt is less expensive than equity, because it is less risky.|
|BREAKING DOWN 'Optimal Capital Structure'||Determinants of Capital Structure Determinants of Capital Structure Capital structure refers to the way a firm chooses to finance its assets and investments through some combination of equity, debt, or internal funds.|
|Capital Structure||A company's proportion of short- and long-term debt is considered when analyzing capital structure.|
|BREAKING DOWN 'Capital Structure'||Labor content and skill - very low, but with skilled overseers Volume - very high Like the assembly line, a continuous flow process has a fixed pace and fixed sequence of activities. Rather than being processed in discrete steps, the product is processed in a continuous flow; its quantity tends to be measured in weight or volume.|
Capital structure or financial leverage deals with a very important financial management question. The other question which hits the mind in the first place is whether a change in the financing mix would have any impact on the value of the firm or not. The question is a valid question as there are some theories which believe that financial mix has an impact on the value and others believe it to be not connected.
How can financial leverage affect the value?
One thing is sure that wherever and whatever way one sources the finance from, it cannot change the operating income levels. The reason is explained further. Changing the financing mix means changing the level of debts and change in levels of debt can impact the interest payable by that firm.
The decrease in interest would increase the net income and thereby the EPS and it is a general belief that the increase in EPS leads to increase in the value of the firm. Apparently, under this view, financial leverage is a useful tool to increase value but, at the same time, nothing comes without a cost.
Financial leverage increases the risk of bankruptcy. It is because higher the level of debt, higher would be the fixed obligation to honor the interest payments to the debts providers.
Discussion of financial leverage has an obvious objective of finding an optimum capital structure leading to maximization of the value of the firm. If the cost of capital is high Important theories or approaches to financial leverage or capital structure or financing mix are as follows: Net Income Approach This approach was suggested by Durand and he was in the favor of financial leverage decision.
According to him, change in financial leverage would lead to a change in the cost of capital. In short, if the ratio of debt in the capital structure increases, the weighted average cost of capital decreases and hence the value of the firm. It says that the weighted average cost of capital remains constant.
It believes in the fact that the market analyses firm as a whole which discounts at a particular rate which is not related to debt-equity ratio. Traditional Approach This approach is not defined hard and fast facts but it says that cost of capital is a function of the capital structure.
The special thing about this approach is that it believes an optimal capital structure. Optimal capital structure implies that at a particular ratio of debt and equity, the cost of capital is minimum and value of the firm is maximum.
MM theory proposed two propositions. It says that the capital structure is irrelevant to the value of a firm. The value of two identical firms would be same and it would not be affected by the mode of finance adopted to finance the assets.
The value of a firm is dependent on the expected future earnings. It says that the financial leverage boosts the expected earnings but it does not increase the value of the firm because the increase in earnings is compensated by the change in the required rate of return.
To summarize, it is essential for finance professionals to know about the nitty-gritty of capital structure they have suggested to the management.
Accurate analysis of capital structure can help a company save on the part of their cost of capital and hence improve profitability for the shareholders.Capital structure describes how a corporation finances its assets.
This structure is usually a combination of several sources of senior debt, mezzanine debt and equity. Wise companies use the right combination of senior debt, mezzanine debt and equity to keep their true cost of capital as low as possible.
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.
Using a comprehensive sample of nearly 7, firms from to , we examine the corporate board structure, trends, and determinants. Guided by recent theoretical work, we find that board structure across firms is consistent with the costs and benefits of the board's monitoring and advising roles.
The present study goes beyond traditional finance paradigms by incorporating elements from divergent perspectives, including family business, finance, economics, and management, to explore capital structure decision-making processes.
Capital Structure and its Theories Capital Structure Theories deals with the question whether a change in capital structure influences the value of a firm. There are four approaches to this, viz. net income, net operating income, .
The term capital structure refers to the percentage of capital (money) at work in a business by type. Broadly speaking, there are two forms of capital: equity capital and debt capital.