Capital Structure
Stewart C. Myers
The Journal of Economic Perspectives, Vol. 15, No. 2. (Spring, 2001), pp. 81-102.
Stable URL: http://links.jstor.org/sici?sici=0895-3309%28200121%2915%3A2%3C81%3ACS%3E2.0.CO%3B2-D The Journal of Economic Perspectives is currently published by American Economic Association.
Your use of the JSTOR archive indicates your acceptance of JSTOR 's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR 's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use.
Please
…show more content…
Most research on capital structure has focused on public, nonfinancial corporations with access to U.S. or international capital markets. This is the right place to start. These companies have the broadest menu of financing choices and can adjust their capital structures at relatively low cost. Yet even 40 years after the
Modigliani and Miller research, our understanding of these firms ' financing choices is limited. We know much more about financing tactics-for example the tax-efficient design or timing of a specific security issue-than about financing strategy, for example the firm 's choice of a target overall debt level.
Research on financing tactics confirms the importance of taxes, information differences and agency costs. Whether these factors have first-order effects on the overall levels of debt vs. equity financing is still an open question. Debt ratios of established, public U.S. corporations vary within apparently homogenous industries.
There is also variation over time, even when taxation, information differences and agency problems are apparently constant.
Some Facts about Financing
Most of the aggregate gross investment by U.S. nonfinancial corporations has been financed from internal cash flow (depreciation and retained earnings).
External financing in most years covers less than 20 percent of real investment, and most of that financing is debt. Net stock issues are frequently negative: that is, more
replacing some of the existing equity by issuing more debt will increase the value of the firm. If
The 20%/9% Bonds and Common Stock option does not generate as positive capital structure as 50%/50% option. Although EPS scores are the same for year nine, net income is reduced to 39,680 due to having to pay interest of 14,400 on bonds while the 50/50 option generates a net income of 49,049 and pays no interest on bonds and issues dividends. In year ten, both capital structures offer an EPS of .032 however the net income is 9,380 less than the 50/50 option. In years 11, 12, and 13, the 20%/9% Bonds and Common Stock option EPS and net income results decline while the EPS and net income results increase for the 50/50 option.
You need to utilize at least two scholarly sources (excluding your text) for this paper and your paper must be formatted according to APA style guidelines as outlined in the Ashford Writing Center.
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase
Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For
Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher
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.
Due to high investment in fixed asset the firm also need a high amount of debt in order to cover its expenses so the smooth run of business.
Diageo was formed in 1997 through the merger of two consumer product companies Grand Metropolitan plc and Guinness plc under the strategy of reducing costs through marketing synergies, cutting overhead expenses and increasing production and purchasing efficiencies. The new merger wanted to concentrate solely on the beverage alcohol business, so it sold its packaged foods (Pillsbury) and fast food (Burger King) businesses. While the mandate for Managing for Value came from the highest levels of Diageo, the treasury team was given the task of establishing the cost of capital for each of the different areas the company operated. The team had to create a simulation model which should consider new finance
Capital structure theory provides some insights into the value of debt verses equity financing. Modern capital structure theory began in 1958, when Modigliani and Miller proved, under a very restrictive set of assumptions, that a firm’s value is unaffected by its capital structure. There are 4 theories:
Capital structure shows that how a firm’s assets have been established debt and equity, it is very important in a firm, because it is related to the capacity of the company to suit the needs of its stakeholders. The capital structure impacts on the performance of the firm, because it can influence the top management of the company decision making (Hitt, Hoskisson and Harrison, 1991).For example, a company has 20million in equity and 80 million in debt. It can be defined as 20% equity-financed and 80% debt-financed. The ratio of debt to total financing companies, 80% in this example, is called the leverage of the company. In reality, the capital structure may be very complex, including dozens of sources. Gearing ratio is the capital from outside the business by the company adopted, such as taking a short term loan (Capital Structure Overview and Theory 2014).
If the firms funding requirements are larger than their retained earnings, they must issue debt as this is preferred to issuing equity. Based on this theory, a firm’s financing policies could be viewed as signalling management’s view of the firm’s stock value (Wang & Lin 2010).Myers and Majluf (1984) also add that if firms issued no new securities but only used its retained earning to support the investment opportunities, the information asymmetric could be resolved. This suggests that issuing equity turn out to be more expensive as asymmetric information insiders and outsiders increase. Large firms should then issue debt to avoid selling under priced securities. As the requirement for external financing increases, businesses will work down the pecking order, from safe to riskier debt, perhaps to convertible securities or preferred stock, and finally to equity as a last resort. Each firm's debt ratio therefore reflects its cumulative requirement for external financing (Myers 2001).The pecking order theory clarifies why the bulk of external financing comes from debt. It also describes why organizations that are more profitable borrow less: since their goal debt ratio is, low-in the pecking order they do not have a goal since profitable firms have more internal financing available.
The test results were also well document throughout the study. It found that deficits due to investment were financed with long- term and short- term in addition to equity. Market timing cannot totally explain equity issuance as profit deficits were often financed with equity. The study found that companies use equity to fund internal investments such as advertising and Research and Development.
Your use of the JSTOR archive indicates your acceptance of JSTOR 's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR 's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher