Capital Structure and Leverage

Capital Structure and Leverage

by Jennifer Aguanta

​Capital Structure

​The capital structure is how a firm finances its overall operations and growth by using different sources of funds.

​Capital Structure Planning

• After simple watching the balance sheet of company, you see two sides of balance sheet. One side is liability side and other side is asset side.

• Liability side is the mixture of finance of company and it has been used or will be used for development of company. Liability side of balance sheet is made under perfect capital structure planning

• Capital structure planning makes strong balance sheet.

• The right capital structure planning also increases the power of company to face the losses and changes in financial markets.​

​Optimal Capital Structure

Influenced by the following primary factors:

1. Business Risk

2. ​Tax position

3. ​Financial Flexibility

4. ​Managerial Conservatism or Aggressiveness

​Business risk

• ​the single most important determinant of capital structure, and it represents the amount of risk that is inherent in the firm’s operations even if it uses no debt financing

​Financial risk

​the additional risk placed on the common stockholders because of the decision to finance with debt

Multiple Choice

The more stable the demand of a business' product, the lower is its business risk

• Demand variability

• Sales price variability

• Input cost variability

• Economic variability

Multiple Choice

Firms whose products are sold in highly volatile markets are exposed to more business risk than similar firms whose output prices are more stable.

• Demand variability

• Sales price variability

• Input cost variability

• Ability to adjust output prices due to input cost

Multiple Choice

Firms whose input costs are highly uncertain are exposed to a high degree of business risk.

• Demand variability

• Sales price variability

• Input cost variability

• Ability to adjust output prices due to input cost

Multiple Choice

The greater the ability to adjust output prices to reflect cost conditions, the lower the degree of business risk.

• Ability to develop new products

• Sales price var

• Ability to adjust output prices for changes in input cost

• Demand variability

Multiple Choice

The faster a firm’s products become obsolete, the greater the firm’s business risk.

• Ability to adjust output prices for changes in input costs

• Ability to develop new products in a timely, cost-efficient manner

• Foreign risk exposure

• The extent to which costs are fixed: operating leverage

Multiple Choice

Firms that generate a high percentage of their earnings overseas are subject to earnings declines due to exchange rate fluctuations.

• Demand variability

• Sales price variability

• Foreign risk exposure

• The extent to which costs are fixed: operating leverage

Multiple Choice

If a high percentage of its costs are fixed, the firm will be exposed to a relatively high degree of business risk.

• Ability to develop new products in a timely, cost-efficient manner

• Extent to which costs are fixed: operating leverage

• Input cost variability

• Ability to adjust output prices for changes in input costs

​CHECKLIST FOR CAPITAL STRUCTURE DECISIONS

​

Poll

Click the items necessary for capital structure decisions

• Sales stability

• Asset structure

• Operating leverage

• Growth rate

Poll

Click the items necessary for capital structure decisions

• Profitability

• Taxes

• Control

• Management attitudes

Poll

Click the items necessary for capital structure decisions

• Lender and rating agency attitudes

• Market conditions

• The firm’s internal condition

• Financial flexibility

​Thank you!

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