Articles Relating to Capital Structure-Essay

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.

2) Is Diageo’s current capital structure appropriate to its new business? It believes that it has traditionally had a conservative debt policy. If so, is that policy still appropriate? Has Diageo’s capital structure been as conservative

c) Optimization of the capital structure is also consistent with the growth of the company. The optimal capital structure

As shown in the financial income statement (Exhibit3), Intel Corp. (INTC) has a capital structure consisting most of equity. Intel has very little debt in its capital structure and the cost of debt would have only a marginal effect on the overall cost of capital. The current capital structure of Intel is not optimal yet since optimal capital structure is making minimum weighted-average cost of capital.

Nevertheless, the use of the Optimal Capital Structure (OCS) is the right techniques to be used in order to acquire the right combination of debt and equity that can maximize the

Most corporate financing decisions in practice reduce to a choice between debt and equity. The finance manager wishing to fund a new project, but reluctant to cut dividends or to make a rights issue, which leads to the decision of borrowing options. The issue with regards to shareholder objectives being met by the management in making financing decisions has come to become a major issue of recent times. This relates to understanding the concept of the agency problem. It deals with the separation of ownership and control of an organisation within a financial context. The financial manager can raise long-term funds internally, from the company’s cash flow, or externally, via the capital market, the market for funds

managers may not directly set the cost of capital, they play a large role in determining the capital structure

Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that

The purpose of the report is to understand the capital structure of the chosen company on the basis of the financial statements of the company which includes the income statement, balance sheet and the cash flow statement of the company and do the capital analysis of the company as well to find out the advantages and disadvantages in working capital of the company and suggest company logical and useful ways for growing their economy.

According to the Equilibrium Theory, a company has reached its optimal capital structure when it minimizes the total sum of taxes paid and the cost of financial distress. Taxes paid and the costs of financial distress develop in opposite directions as the interest coverage ratio (EBIT/interest) changes. While the tax shield effect and thus the amount of taxes paid at different coverage ratios can easily be calculated using the marginal tax rate (in the case of Diageo 27%), the cost of financial distress has to be approximated using sophisticated financial models (e.g. Monte Carlo Analysis) that take into account probabilities of different direct and indirect costs of financial distress.

The course project involved developing a great depth of knowledge in analyzing capital structure, theories behind it, and its risks and issues. Before I began this assignment, I knew nothing but a few things about capital structure from previous unit weeks; however, it was not until this course’s final project that came along with opening

Financing a firm through the fluctuations of a business cycle is never an easy proposition. Tradeoffs must be made between numerous, competing considerations that include creditor obligations, stakeholder concerns, and future tax liabilities (Sihler, Crawford & Davis, 2004). Though it was once thought that “capital structure has no effect on the value of the firm,” most modern analysts no longer operate under that assumption (Kester & Hoover, 2005, p. 61). Indeed, it is now almost universally agreed that factors like debt and tax obligations certainly do affect a firm’s monetary valuation (Kester & Hoover, 2005). Fortunately, analysts have been kind enough to develop valuation models, such as FRICTO, which can help guide the financing process and enable managers and stakeholders to avoid the various pitfalls that can confront a firm in its quest to stay afloat (Sihler, Crawford & Davis, 2004).

The Modigliani and Miller(1958) theory developed the proposition that in perfect markets, with absence of taxes, transaction costs, bankruptcy costs and asymmetric information, the value of the firm is not affected by how it is financed by its capital structure, also the weighted average cost of capital (WACC) will remain the same even if the firm's capital structure changes. For example, regardless of how much loan the firm borrows from its creditors, there will be no tax benefit gained from the interest payments it received, therefore there will be no changes made to the WACC. Since there is no benefit receiving from increases in debt, it means the capital structure does not affect a company's share price, thus the capital structure is unrelated to a company's share price.

Already in 1958, Modigliani and Miller have pointed the discussion of capital structure towards the cost of debt and equity. According to their first proposition, in a world of no corporate taxes and with perfect markets, financial leverage has no effect on a firm’s value. In their second proposition, they state that the cost of equity equals a linear function defined by the required return on assets and the cost of debt (Modigliani and Miller, 1958).

Harris and Reviv (1990) gave one more reason of using debt in capital structure. They say that management will hide information from shareholders about the liquidation of the firm even if the liquidation will be in the best interest of shareholders because managers want the perpetuation of their service. Similarly, Amihud and Lev (1981) suggest that mangers have incentives to pursue strategies that reduce their employment risk. This conflict can be solved by increasing the use of debt financing since bondholders will take control of the firm in case of default as they are powered to do so by the debt indentures. Stulz (1990) said when shareholders cannot observe either the investing decisions of management or the cash flow position in the firm, they will use debt financing. Managers, to maintain credibility, will over-invest if it has extra cash and under-invest if it has limited cash. Stulz (1990) argued that to reduce the cost of underinvestment and overinvestment, the amount of free cash flow should be reduced to