五彩缤纷的什么 Capital Structure and Firm Performance
What is Capital Structure and good Capital Structure?
The term capital structure refers to the mix of different types of funds which a company us to finance its activities.
In summary, we often assume that companies are financed by just two types of funds, shareholders funds (equity) and borrowings (debt), and we will consider the effect on the cost of capital of varying the proportion of debt in the capital structure.
Then, somebody will ask what is a good capital structure. so a good capital structure is a capital structure which results in a low overall cost of capital for the company that is a low overall rate of return that needs to be paid on funds provided. If the cost of capital is low, then the discounted value of future cash flows generated by the company is high, resulting in a high overall company value. The objective is therefore to find the capital structure that gives the lowest overall cost of capital and, conquently, the highest company value.
Effects of borrowing
Suppo our company is financed entirely by ordinary shares (equity). What would be the effects of issuing some debt capital? Following we have identified two distinct advantages and two distinct disadvantages The main advantage of borrowing is that debt has a cheaper direct cost than equity. There are two distinct reasons for this:
1.debt is less risky to the investor than equity (low risk results in a low required return);
2.interest payments are allowable against corporate taxation, whereas dividends are not.
However, borrowing has two distinct disadvantages.
We can discuss in detail following for the disadvantages:
1. it caus shareholders to suffer incread volatility of earnings. This is known as financial leverage. For example, if a firm is financed entirely by equity, a 10% reduction in operating earnings will result in a 10% reduction in earnings per share. But if the firm is fi
nanced by debt as well as equity, a 10% reduction in operating earnings caus a greater reduction in earnings per share than 10%, becau debt interest does not reduce in line with operating earnings. The incread volatility to shareholders’ returns resulting from financial leverage caus shareholders to demand a higher rate of return in compensation. In other words, any borrowing at all will cau the cost of equity capital to ri, off-tting the cheap direct cost of debt.
2.The cond disadvantage of borrowing is that if the company borrows too much, it increas its bankruptcy risks. At reasonable levels of gearing this effect will be imperceptible, but it becomes significant for highly geared companies and results in a range of risks and costs which have the effect of increasing the company?s cost of capital.
We also can u the table following to talk ahout:
| 桂的成语 Advantages | Disadvantages |
1. Cheap direct cost becau debt is less risky to the investor | 1. Financial leverage caus shareholders to increa their cost of capital |
不时之需2. Cheap direct cost becau interest is a tax deductible expen. | 2. Bankruptcy risks if borrowings are too high | 五子连
| |
When you invest in a company, you need to look at many different financial records to e if it is a worthwhile investment. But what does it mean to you if, after doing all your rearch, you invest in a company and then it decides to borrow money? Here we take a look at how you can evaluate whether the debt will affect your investment.
How Do Companies Borrow Money?
There are two main methods by which a company can borrow money: (1) by issuing 咸鹅蛋fixed-income (debt) curities - like bonds, notes, bills and corporate papers - and (2) by taking out a loan at a bank or lending institution.
Fixed-Income Securities - Debt curities issued by the company are purchad by investors, so, when you buy any type of fixed-income curity, you are in esnce lending money to a business or government. When issuing the curities, the company must pay underwriting fees. However, debt curities allow the company to rai more money and to borrow for longer durations than loans typically allow.
Loans - Borrowing from a private entity means going to a bank for a loan or a line of credit. Companies will commonly have open lines of credit from which they may draw in o
rder to meet their cash requirements of day-to-day activities. The loan a company borrows from an institution may be ud to pay for the company payrolls, buy inventories and new equipment, or to keep as a safety net. For the most part, loans require repayment in a shorter time period than most fixed income curities.
Is there an optimal debt-equity relationship?
In financial terms, debt is a good example of the proverbial two-edged sword. Astute u of leverage (debt) increas the amount of financial resources available to a company for growth and expansion. The assumption is that management can earn more on borrowed funds than it pays in interest expen and fees on the funds. However, as successful as this formula may em, it does require that a company maintain a solid record of complying with its various borrowing commitments.
A company considered too highly leveraged (too much debt versus equity) may find its freedom of action restricted by its creditors and/or may have its profitability hurt as a result of paying high interest costs. Of cour, the worst-ca scenario would be having tr
ouble meeting operating and debt liabilities during periods of adver economic conditions. Lastly, a company in a highly competitive business, if hobbled by high debt, may find its competitors taking advantage of its problems to grab more market share.观察黄豆发芽日记
Unfortunately, there is no magic proportion of debt that a company can take on. The debt-equity relationship varies according to industries involved, a company's line of business and its stage of development. However, becau investors are better off putting their money into companies with strong balance sheets, common n tells us that the companies should have, generally speaking, lower debt and higher equity levels.
How to evaluate a company’s capital position
Capital structure varies greatly from one company to another. For example, some companies are financed mainly by shareholders?减肥廋身 funds whereas others make much greater u of borrowings. In this article we consider some of the arguments that have been put forward in answer to the question ? Are some capital structures better than others?
In general, analysts u three different ratios to asss the financial strength of a company's capitalization structure. The first two, the so-called debt and debt/equity ratios, are popular measurements; however, it's the capitalization ratio that delivers the key insights to evaluating a company's capital position.
The debt ratio compares total liabilities to total asts. Obviously, more of the former means less equity and, therefore, indicates a more leveraged position. The problem with this measurement is that it is too broad in scope, which, as a conquence, gives equal weight to operational and debt liabilities.
