Capital Structure: Definition, Factors, Types, Importance,l and Examples | Bajaj Finance (2024)

FAQs

What is capital structure and types of capital structure? ›

Capital structure can be a mixture of a company's long-term debt, short-term debt, common stock, and preferred stock. A company's proportion of short-term debt versus long-term debt is considered when analyzing its capital structure.

Some main factors include the firm's cost of capital, nature, size, capital markets condition, debt-to-equity ratio, and ownership. However, these factors might help to choose an appropriate capital structure for a business, but checking all the side factors can help adopt more appropriate and accurate adaption.

Let's consider two different examples of capital structure: Company A, for our purposes, has $150,000 in assets and $50,000 in liabilities. This means Company A's equity is $100,000. The company's capital structure is therefore such that for every 50 cents of debt, the company makes $1 of equity.

Importance of Capital Structure

A good capital structure ensures that the available funds are used effectively. It prevents over or under capitalisation. It helps the company in increasing its profits in the form of higher returns to stakeholders.

Examples of structured investments include: term loans with warrants, convertible debt, preferred stock with dividends, royalties, and hybrids or combinations of these instruments.

The principles of structure include maintaining an optimal balance between equity and debt. It includes considering the cost of capital, aligning with the company's risk tolerance, and adjusting to economic conditions.

The Capital Structure is the mixture of debt, preferred stock, and common equity used by a company to fund its operations and purchase assets.

Capital is a factor of production that has been produced for use in the production of other goods and services. Office buildings, machinery, and tools are examples of capital. Natural resources are the resources of nature that can be used for the production of goods and services.

Capital Structure refers to the proportion of money that is invested in a business. It has four components and it includes Equity Capital, Reserves and Surplus, Net Worth, Total Borrowings. It represents the risk capital staked by the owners through purchase of Owners Company's common stock.

The optimal capital structure is estimated by calculating the mix of debt and equity that minimizes the weighted average cost of capital (WACC) of a company while maximizing its market value. The lower the cost of capital, the greater the present value of the firm's future cash flows, discounted by the WACC.

What are the advantages and disadvantages of capital structure? ›

The advantages of this type of capital structure include lower cost of capital, tax deductibility of interest payments, and increased financial leverage. However, the disadvantages include higher risk of default, reduced flexibility, and potential conflicts with creditors.

Capital structure is the mix of debt and equity on a company's balance sheet. It shows how much of a company is financed by creditors and owners, and also provides insights into the company's cost of capital—how much the capital in the business is costing the owners.

The types of capital structure are equity share capital, debt, preference share capital, and vendor finance. In addition, it ensures accurate funds utilization for business. The right capital structure level decreases the overall capital cost to the highest level. Also, it increases the public entity's valuation.

Tangibility of assets, growth opportunities, size, uniqueness, business risk, and profitability are some of the major factors which determine the capital structure. However, the significance of these determinants may vary from country to country depending on their economy settings.

A company's capital structure — essentially, its blend of equity and debt financing — is a significant factor in valuing the business. The relative levels of equity and debt affect risk and cash flow and, therefore, the amount an investor would be willing to pay for the company or for an interest in it.

Answer: There are four important capital structure theories: net income theory, net operating income theory, traditional theory, and Modigliani-Miller theory.

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Key Takeaways. The Modigliani-Miller theorem states that a company's capital structure is not a factor in its value. Market value is determined by the present value of future earnings, the theorem states. The theorem has been highly influential since it was introduced in the 1950s.

The capital structure is a mix of equity and debt used to manage the business and run the operational processes while fostering the organisation's growth. The total capital of a company is made up of two types: equity and debt capital.