Capital Structure - Essay Example

Capital Structure In the present competitive scenario, companies are required to conduct business operations with incorporating the aspect of better investment management. In this similar context, I identified that the capital requirement of a firm is dependent on two sources that mainly include equity and debt. Respectively, I conjure that varied capital sources are typically based on different costs and thus, needed appropriate analysis for designing an optimal capital structure for raising required finance appropriately (Grundy, n.d.).

In businesses, sources of capital comprise equity and debt, which are used individually or in a mixed way. I strongly believe in this context that the use of debt and equity in a proportionate manner aids in raising capital. Thus, based on my understanding, businesses are identified to consider two important elements that include “cost of capital” and “Weighted Average Cost of Capital” (WACC) for the purpose of accomplishing their respective business targets in long term. Subsequently, by mixing debt and equity, the aforesaid two elements can be reduced as per my knowledge.

I think that obtaining debt in an adequate manner as a source of capital ensures in generating low and real risks of financial distress (Grundy, n.d.). In this regard, I support the fact that the use of only debt financing or equity financing is accountable for making financial distress in long run. As per my understanding, market values play an imperative role for companies at the time of raising capital. These are important as investors invest based on firms’ value and risks associated with businesses.

Subsequently, I consider that there exists a complex relationship prevailing between WACC and debt, as increased amount of debt has positive as well as negative influences on the capital structure of a company. Consequently, I conjure that WACC values increase for more returns and on the other hand, these decreases for low cost of debt as compared to equity. In this regard, from the viewpoints of Modigliani & Miller, I understood that the market value of companies is not based on their respective capital structure totally but is also dependent on other factors (Grundy, n.d.).

I strongly believed that gearing is a procedure of ascertaining capital structure of a company based on the relationship persisting between equity and debt. Thus, movements of WACC and share price impose significant impact on shareholders’ wealth. In this regard, the best example of understanding different aspects of debt and equity financing is Sunview Holiday Plc as per my idea. In this regard, I observed that Sunview Holiday Plc with the assistance of gearing has been able to improve shareholders’ returns and company’s value at large.

The company’s Board noted that financial risks have an effect on share price, which is influencing the capital structure largely. As per my understanding, a change in share price influences investment and rate of return. Thus, based on the above discussed aspects, I must say that share price has a direct influence on shareholders’ returns (Grundy, n.d.). Thus, I believe that companies are required to have a balance of debt and equity with the aim of formulating an optimum capital structure.

ReferenceGrundy, D. (n.d). International corporate finance and financial management. Capital Structure.