The relevance of a company capital structure has been the subject of several theories and debate. The capital structure of a company is a mix of different securities. Capital structure refers to the way a corporation finances itself through a combination of equity sales, equity option, bonds and loans. So it is essentially a debate over the proportion of debt and equity financing the company. However capital structure is not just a question about debt and equity. There are multiple compositions of debt or equity and convertible bonds. The aim of every company is run a profitable business. An optimal capital structure refers to the particular combination which minimizes the cost of capital, and maximizing the stock price. It's an important financial decision undertaken by the managers of the company. It's necessary to assess the effect of the capital structure choice on the investor's behaviour. The proportion of debt and equity has an implication for stockholder value.
[...] Modigliani and Miller's theories Franco Modigliani and Merton Miller, know as have influenced a lot people who want to understand the influence of the capital structure on the company's value. A company can choose between three methods of financing: issuing shares, borrowing, and spending profits. There are two main theories and some revisions made by Modigliani and Miller, or Miller only. In 1958, the first theory showed that company value is independent of capital structure. According to Miller a company can reduce its cost of capital by finding the right debt equity ratio. [...]
[...] II Several methods to choice a relevant financing mix The traditional view of capital structure The traditional view explains that there is an optimal level of gearing through an optimal capital structure. And it's the use of debt financing which increases its value. The cost of capital is not independent of capital structure of the firm. Therefore the value of a company is not independent of capital structure. As a result for the traditional approach, an optimal capital structure exists. [...]
[...] To conclude, an ideal capital structure is one that the trade off between the cost of capital and the benefit is maximised. However both debt and equity have limitations suggesting there is no perfect capital structure. Restrictions may prohibit obtaining a managers preferred debt- equity mix. The theories suggest that companies select a capital structure depending on attributes that determine various costs and benefits associated with debt and equity financing. The nature of each company will determine an ideal mix. [...]
[...] is there a perfect capital structure? On the one and, it's relevant to recognize and to assess a capital structure through some determinants and some measurement methods. On the other hand, it's necessary to know how to choice a relevant financing mix thanks to the traditional view, and Miller and Modigliani theories. I - How recognize and assess a capital structure? Main determinants of capital structure: equity versus debt The first advantage of debt financing is that it allows to the manager to retain ownership and control of the company. [...]
[...] They said that there is a constant line to identify the relationship between the cost of capital and all degrees of leverage. These papers showed a fundamental objection to the traditional view of corporate finance. The traditional view argued that a company can reduce its cost of capital by finding the right debt-equity ratio. According to M&M there is no right ratio. These theories are supported by the arbitrage theory. Thanks to the market, the values of companies which have the same risk and return characteristic are equal. [...]
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