Optimal Capital Structure

  • Uncategorized

OPTIMAL CAPITAL STRUCTURE 1

Companies use a capital structure to describe how it sources itsfinancial resources that help in running its everyday activities.Companies adopt various forms of capital structures to meet theirinternal financial needs as well as those of the shareholders (Berket al., 2010). The optimal capital structure is a universal methodthat all company scan employ in to raise enough funds for running itsactivities and maintain good returns to the shareholders (Dalal,2013). The optimal capital structure is advantageous to the businessin various ways.

First, it results in the efficient use of capital. A company needscapital to procure expensive assets. For example, an airline companymay borrow to expand its fleet in anticipation of increased number ofpassengers. However, relying on debt equity leads to a drop incapital efficiency. An optimal structure helps the company to retainan optimal debt at low-interest rates and hence greater efficiency incapital utilization (Berk et al., 2010).

Secondly, there are fewer risks associated with the optimal capitalstructure. Debt leverage ratios compare a company’s debt reliancewith its equity, assets and equity. An optimal financial structurehas few financial risks. It advises the company on the limit ofborrowing and, therefore, preventing the company from becomingbankrupt (Hackbarth &amp Mauer, 2011). For example, in the airlineindustry that may require a lot of capital to buy a new fleet, it maycapitalize on capital investing to a point of having shareholderscontrolling the company. An optimal structure can prevent this effectby setting a ceiling on equity financing.

Finally, a company should employ the optimal financial capital toretain its customers. Without making enough profit that is enough togive investors good returns, a company can lose some of itscustomers. It can result when most if the investors equity is use toacquire capital

(Hackbarth &amp Mauer, 2011). An optimal capital structure helps inturning over the necessary percentage of ownership to avoid expensivefinancing.

References

Berk, J. B.,Stanton, R., &amp Zechner, J. (2010). Human capital, bankruptcy, andcapital structure. The Journal of Finance, 65(3),891-926.

Dalal, G. (2013).Optimal capital structure. International Journal of Education andManagement Studies, 3(1), 138.

Hackbarth, D., &ampMauer, D. C. (2011). Optimal priority structure, capital structure,and investment. Review of Financial Studies, hhr129.

Close Menu