Capital Structure Of A Company

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I. EXECUTIVE SUMMARY/ABSTRACT The Part-I of this paper analyzes the Treasury Manager and his various approaches towards the Capital Structure, by showing arguments for and against each theory. We discuss about four types of approaches that may be taken by the treasury manager while considering the Capital Structure of a Company. We have discussed Rolls Royce PLC’s capital structure strategy and analyzed the capital structure of the company over the past 10 years using an empirical case/research. The Part-II of this paper shows the relationship between private equity groups and leverage. We discuss about how the leverage is used by private equity groups to reduce the risk, by showing an empirical case of Blackstone Group.…show more content…
Debt structuring can be a handy option because the interest payable on debts is tax deductible (deductible from net profit before tax). Hence, debt is a cheaper source of finance. But increasing debt has its own share of drawbacks like increased risk of bankruptcy, increased fixed interest obligations etc. For finding the optimum capital structure in order to maximize shareholder’s wealth or value of the firm, different theories (approaches) have evolved. PART- I III. TYPES OF CAPITAL STRUCTURE APPROACH a. Traditional Approach The traditional theory of capital structure describes the existence of optimal debt to equity ratio, where the cost of capital is minimum and the market value of a firm is maximum. The changes in the financing mix can bring positive change to the value of the firm. Before the changes in the financing mix, the marginal cost of debt is less than cost of equity and after the change; the marginal cost of debt is higher than that of equity. This theory supports the combination of the equity and debt ratio of the capital structure of a firm when the market value is at its maximum. The debt in the capital structure of a firm can only be up to a certain point, any increase beyond that point can cause the increase in the leverage and can result in the decrease in the market value of a firm. This means that there exists an optimum value of debt to equity ratio at which the WACC is the lowest and the market value of the firm is the highest. It shows
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