Capital Structure Of A Company

2836 Words12 Pages
MODERN FINANCE
CAPITAL STRUCTURE
The capital structure of a company refers to the mixture of equity and debt finance used by the company to finance its assets. Capital structure is the proportion of firm’s value financed with debt. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings.Short-term debt such as working capital requirements is also considered to be part of the capital structure. Some companies could be all-equity-financed and have no debt at all, whilst others could have low levels of equity and high levels of debt. The decision on what mixture of equity and debt capital to have is called the
…show more content…
Repurchasing stock also alters a firm 's capital structure as buying back shares decreases equity, which increases a firm 's leverage ratio. Open market share repurchases, the most popular form of repurchase, are generally interpreted as good news by the stock market and hence are greeted with abnormal returns of approximately 2% to 3% on average.There is, however, a non-trivial variation in the market reaction to share repurchases, implying that investors view repurchases as better news for some firms than for others.

Importance of capital structure it makes economic sense for the firm to strive to minimize the cost of using financial capital both capital costs and other costs, these cost are manufacturing cost share a common characteristic in that they potentially reduce the size of the cash dividend that could be paid to common stockholders
The traditional approach to capital structure
The first view of capital structure shall be considered as the traditional approach.
The proposition of the traditional approach to capital structure is that an optimal capital structure does not exist and that a company can therefore increase its total value by the sensible use of debt finance within its capital structure. (Figure add 283 5th edition)
The arbitrage approach to capital structure
Arbitrage theory states that goods which are perfect substitutes for each other
Get Access