Author’s Details: Institutional Affiliation: Theory of extreme capital structure. The term structure denotes the arrangement of the various factors to form a building. In capital formation, the various factors are the capital sources that a company uses in establishing its base…
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Therefore, capital structure can be defined as the arrangement of capital. In order to analyse capital structure, we need to highlight the difference between capital structure and financial structure. The terms are interchanged in some circles to mean the same, but they are not quite the same. Financial structure is the sum of all the means the firm uses to fund its activities. Therefore, financial structure comprises of net worth and liabilities of the company i.e. short and long term. The capital structure on the other hand is financial structure excluding short term borrowing. Capital structure has already been seen as two-fold, with the finance and asset structure. The source of capital is what determines what asset will be purchased. The structure of capital is categorised as follows: 1. According to sources: The structure may either be simple or complex. A simple structure consists of a single source while the complex is where the sources are more than one. (Although retained earnings is not considered an additional source). This mode is only possible under the fund concept because it is rare for a firm to have one asset, invalidating the asset concept. 2. According to sources This is broadly categorised into internal and external sources. Internal sources comprise of share capital (bonus issue), capital reserve, and reserve and surplus. On the hand the external sources include share capital (bonus issue excluded), share premium, forfeited shares, long term and short-term liabilities and debentures. 3. According to ownership This is either ownership capital or creditorship (debt) capital. Ownership capital includes equity share capital and retained earnings while creditorship comprises of debentures, long-term and short-term liabilities. It is agreed by all accountants where preference shares should be grouped as they have the both elements of ownership and debt. 4. According to cost behaviour This classifies the assets as either fixed cost or variable cost, depending on their expense implications. The fixed cost capital include preference share, long term debt and debentures whereas variable cost capital include equity share and short term liabilities. Firms have different capital structures depending on industry, company type, and proportion of capital contribution. The theories of capital structure try to ask the pertinent questions in leveraging, valuation, and financial balance. This involves evaluating how a firm can affect its total valuation factoring debt and equity, how debt affects the firm’s position. This is by use of accounting ratios 1 Where is the firm’s debt yield, assuming the element of perpetuity of debt 2. [E=EBIT-I] Where we assume 100% dividend payout and the firms earning are constant with no element of growth. Therefore, the earnings/price ratio gives the market discount rate, which equals the present value of the series of expected future dividends at the existing market value of the share. 3. Where is the firm’s overall capitalisation rate. It computation is normally the weighting of the cost of capital as shown below + The theories of capital structure try to explain the relationship between capital, leverage and the firm’s value. What we want to know is what happens to , and when the degree of leverage (D/V) increases or how is the value of capital
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Theory of Extreme Capital Structure Essay Example | Topics and Well Written Essays - 1500 Words. https://studentshare.org/statistics/1449485-quantitative-research-methods.
“Theory of Extreme Capital Structure Essay Example | Topics and Well Written Essays - 1500 Words”, n.d. https://studentshare.org/statistics/1449485-quantitative-research-methods.
In the second part of the project, the risks associated with the company have been analyzed based on the financial and non-financial factors. In the third part of the project, a brief description has been given on the capital structure theory and its implications on the business.
One of its main suggestions is that managers can help in heightening the shareholders’ wealth by ensuring that they give a right timing to issues related to security. Most studies that have tested the market timing theory have found out that particular factors tend to affect security decisions for instance, interest rates and past stock prices.
They also recommended that an ideal capital structure of a firm is with all debt with cheaper debt finance than higher cost & riskier equity but an optimal capital structure exists in which the terms of debt financing & such other real world problems of debt financing (like bankruptcy due to high debt) and tax savings of the debt financing are balancing factors (Modigliani and Miller.
The author states that evaluating the financial ratios of CVS shows that it has a debt-equity ratio of 28.4% which has impressively improved as compared to where it stood a year ago, i.e. 38.65% in 2005. This shows that CVS is not highly leveraged and comprises of a large proportion of equity in its capital structure.
Weighted average cost of capital is a measure used to calculate the amount of debt that a firm holds against the amount of equity. However it’s much better to put it this way it’s a measure of the amount of debt that a firm should hold against the amount of equity.
Net Debt Ratio of a company indicates the extent to which the company has been financed by outside or borrowed funds. Here the debt generally includes all types of debts like subordinate debts, senior debts as well as capital debts. The net debt
The following table includes the descriptive statistics of different financial parameters.
The database that has been used for this empirical analysis and calculation has been retrieved from Data Stream. The database
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
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