Optimal capital structure
- 1. Optimal Capital Structure Presented By: Kajal Yadav
- 2. Optimal Capital structure ā¢ Capital structure is the proportion of debt and preference and equity shares on a firmās balance sheet. ā¢ Optimal Capital structure is the capital structure at which the weighted average cost of capital is minimum and thereby maximum value of the firm.
- 3. Features ļ The relationship of debt and equity in an optimal capital structure is made in such a manner that the market value per equity share becomes maximum. ļ It maintains the financial stability of the firm. ļ The finance manager determines the proportion of debt and equity in such a manner that the financial risk remains low. ļ The advantage of the leverage offered by corporate taxes is taken into account in achieving the optimal capital structure. ļ Borrowings help in increasing the value of company leading towards optimal capital structure. ļ The cost of capital reaches at its minimum and market price of share becomes maximum at optimal capital structure.
- 4. Constraints ā¢ The optimum debt-equity mix is difficult to ascertain in true sense. ā¢ The concept of appropriate capital structure is more realistic than the concept of optimum capital structure. ā¢ It is difficult to find an optimum capital structure as the extent to which the market value of an equity share will fall due to increase in risk of high debt content in capital structure, is very difficult to measure. ā¢ The market price of equity share rarely changes due to changes in debt-equity mix, so there cannot be any optimum capital structure. ā¢ It is impossible to predict exactly the amount of decrease in the market value of an equity share because market factors that influence market value of equity share are highly complex.