University Finance: Capital Structure Analysis Report

This report provides an analysis of capital structure, a crucial financial decision affecting a company's value and shareholder returns. It examines the importance of capital structure, highlighting the irrelevance theory of Modigliani and Miller, and contrasts it with real-world considerations. The report discusses the benefits of debt financing, such as tax shields and managerial incentives, while also acknowledging its potential risks like increased financial obligations and the potential for default. It explores the impact of debt on stockholders' risk and the need for managers to balance debt levels to generate cash flow. The report also touches upon the trade-off and pecking order theories of capital structure choice, offering a comprehensive overview of the topic.

Running head: CAPITAL
Capital
Name of the Student:
Name of the University:
Author Note:

1CAPITAL
Table of Contents
Capital Structure:.......................................................................................................................2
References:.................................................................................................................................3

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Capital Structure:
The capital structure of a company is an important financial decision which is taken
by the investment managers or financial managers. The importance of the firm’s capital
structure is an important decision as it significantly affects the value of the firm and
ultimately the value of the stock holders of the company (Tsoy and Heshmati 2017).
The MM model irrelevance theory advocates to the capital structure of the company
being irrelevant and the value of the firm depends on the assets of the company, without the
consideration of the manner in which they are funded. Thus, this is an absurd theory in the
practical world as the assumptions of the irrelevance theory are not present.
The debt funding has several benefits to the company as it provides interest tax shield,
creates incentives for the managers to perform well and is relatively less costly to issue to the
investors. However, the debt funding creates a significant charge on the financial assets of the
company. This means the debt holders are paid their interest on a timely basis or it might lead
to the default in payment which would affect the credit rating of the company. Thus, the debt
holders receive the payment of the interest from the profits before the shareholders. In case of
liquidation, the debt holders are paid off first from the assets of the company and the
shareholders receive what is left in the assets of the company (Dhankar 2019).
Thus, as it is seen the risk for the stockholders increases while the debt holders enjoy
the assets of the company. The managers need to generate cash flow for the timely payment
of interest and principal to the debt holders or it might lead to the default. Thus, excessive
level of debt in the company tends to create negative value for the stock holder of the
company as the management aligns the interest of the debt holders before the stock holders.

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References:
Dhankar, R.S., 2019. Cost of Capital, Capital Structure, Dividend Policy and Value of Firm.
In Capital Markets and Investment Decision Making (pp. 187-196). Springer, New Delhi.
Tsoy, L. and Heshmati, A., 2017. Impact of financial crises on dynamics of capital structure:
evidence from Korean listed companies.