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Finance - Term Paper Example
A specific mix of capital structure incorporating debt and equity is essential to undergo various businesses and finance operation. The financial mix is a crucial structure that affects the risk and brand value of the business. …
The equity finance is an expensive and exclusive method for raising capital in the business and it comprises of ordinary and preference shareholdings, bonds and floating market shares. It also includes a listing cost and legal paper work, potential shareholders and raises wider opportunity for pool of finance (Slee, 2011).
The difference in usage of appropriate financial capital structure is the selection of Leverage the business can be adhered to. It signifies the impact of debt in the company’s capital structure e.g. long-term bonds for 5 to 8 years and their impact on company’s profitability and earning stream (Khan et al., 2005). If the debt ratio is higher in good economic terms than it will also improve the required rate of return and return on equity of the business, similarly, if the debt ratio is higher in terms of recession than it creates a significance risk to the business operations and its sustainable future (Slee, 2011).
According to the conventional theory of Modigliani and Miller (1985), in a perfect world the mix of debt and equity does not matter when economic terms and corporate taxes are assumed to be constant. It also suggested that value of the firm is independent of the financial capital structures and overall operating cost (Cox, 2011). It further argued that if the benefit is obtained due to low cost debt then it could be offset against the cost of equity borrowing that will be considerably higher than the debt finance.