CAPITAL DECISIONS 1
The capital structure of a firm is the result of the trade-offsbetween the benefits of debt and the cost of debt. A company drawsits capital structure from the costs of bankruptcy, tax benefits andagency costs from investments and asset substitution. However, theseare under the influence of the environment in which the firmoperates. The viability of a firm`s institutions and the country’sinstitutional structure affects the capital structure of a company(Oztekin, 2015). Example, an international company operating in aforeign region may be required to have a given equity funding, andthis can significantly affect its capital structure. A capitalstructure influences the decisions of a firm because it affects thefirm’s competitive edge and also the amount of shareholder’swealth. The decisions of a capital structure emanate from the theoryof profitability, shareholder wealth, the cost of debt and the agencycosts (Tudose, 2012).
The capital structure is under the influence of corporate taxes(Faccio & Xu, 2015). Several principles apply to maintain aviable capital structure. They include focusing on the agency costs,bankruptcy costs, the firm’s profitable taxes and the globalinfluences. Managers can use these to forge a good capital structureby making subsequent changes as dictated by the factors.
Capital budgeting involves deciding what to fund and which to reject.A business has numerous projects to pursue, but the limited capitaldictates some of them to be eliminated from the list. For example,when Blackberry wanted to put up a plant in the Asia it had to decideon the location and the size of the plant. The size of the projectwas determined by the expected production and the capital base.Capital budgeting was instrumental in determining te profitability ofthe business.
The possibility f bankruptcy may make it difficult for a firm toremain within its budget. The capital structure defines how a companywill pay for its assets. Companies can either source money fromshareholders taking a loan or selling an asset (Amaya, 2013). Moneyfrom shareholders is referred to as the equity financing, and thecompany gives part of its ownership (Rob& Robbinson, 2013). Themore the debt financing through debt, the more the company facesbankruptcy (Base et al., 2012). Capital budgeting is different fromcapital rationing since it simply defines the viable projectsregardless of their upfront costs.
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Faccio, M., &Xu, J. (2013). Taxes and capital structure. Journal of Financialand Quantitative Analysis (JFQA), Forthcoming.
Öztekin, Ö.(2015). Capital structure decisions around the world: which factorsare reliably important?. Journal of Financial and QuantitativeAnalysis (JFQA), Forthcoming.
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Tudose, M. B.(2012). Capital Structure and Firm Performance. EconomyTransdisciplinarity Cognition, 15(2), 76-82.