Capital Structure Determinants

Topics: Corporate finance, Finance, Capital structure Pages: 16 (5533 words) Published: April 6, 2013
1.1Theories of Capital Structure4
2Review of Literature9
3Need and Significance of the Study13
4Proposed Objectives of the Study14
5Research Design14
5.1Hypotheses Formulated14
5.2Data Sources and Sample Selection15
5.3Period of Study16
5.4Determinants of Leverage16
5.5Tools of Analysis20

Capital Structure is the mix of debt and equity securities that are used to finance the company’s assets. It is defined as the amount of permanent short-term debt, preferred stock and common equity used to finance a firm. Financial structure is sometimes used as synonymous with capital structure. However, financial structure is more comprehensive in the sense that it refers to , in aggregate, the amount of total current liabilities, long-term-debt , preferred stock , and common equity used to finance the firm. Therefore, the capital structure is only a part of the financial structure, which refers mainly to the permanent sources of the firm’s financing. Decisions on the capital structure formulation or long-term financing are influenced by multiple factors. Much of the focus as laid in the research on the subject pertains to the target capital structure, which the firm believes the best in terms of financial goals. In the last three decades, a number of choices have been proposed to explain the variations in the debt-equity ratio among firms. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. The term capital structure basically refers to the percentage of capital (money) at work in a business by type. Broadly speaking, there are two forms of capital: equity capital and debt capital. Each has its own benefits and drawbacks and a substantial part of wise corporate stewardship and management is attempting to find the perfect capital structure in terms of risk / reward payoff for shareholders. This is true for Fortune 500 companies and for small business owners trying to determine how much of their startup money should come from a bank loan without endangering the business. There are two forms of Capital :- Equity Capital: This refers to money put up and owned by the shareholders (owners). Typically, equity capital consists of two types namely, contributed capital, which is the money that was originally invested in the business in exchange for shares of stock or ownership and retained earnings, which represents profits from past years that have been kept by the company and used to strengthen the balance sheet or fund growth, acquisitions, or expansion. Many consider equity capital to be the most expensive type of capital a company can utilize because its ‘cost’ is the return the firm must earn to attract investment. A speculative mining company that is looking for silver in a remote region of Africa may require a much higher return on equity to get investors to purchase the stock than a firm such as Procter & Gamble, which sells everything from toothpaste and shampoo to detergent and beauty products. Debt Capital: The debt capital in a company's capital structure refers to borrowed money that is at work in the business. The safest type is generally considered long-term bonds because the company has years, if not decades, to come up with the principal, while paying interest only in the meantime. Other types of debt capital can include short-term commercial paper utilized by giants such as Wal-Mart and General Electric that amount to billions of dollars in 24-hour loans from the capital markets to meet day-to-day working capital requirements such as payroll and utility bills. The cost of debt capital in the capital structure depends on the health of the company's balance sheet - a triple AAA rated firm is going to be...

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