Capital Structure

In the previous blogs, I talk about Equity Finance and related to it to Facebook share price in the stock market. The old blog is actually focusing on type of  financing for corporate financing and the topic focus was debt or equity finance but i choose equity finance.

Capital structure is how company finance its assets through debt,equity or hybrid securities. It is not surprising that previous blog was related to capital structure because capital structure is the "type of financing for corporate finance". So in a sense corporate finance is actually a system or area dealing with sources of firm's financing. But last week topic does not talk about corporate finance but type of financing sources for it.

in this week blog i'm going to talk of how debt finance and equity finance impact optimal capital structure. Most companies preferred get sources through debts because it is cheaper, less risky, lenders require low rate of return than ordinary share, debt interest is reduced by tax paid and debt is suitable for issuing and transaction costs.  But not matter how much profit you have or good financial year, companies still need to pay huge amount of debts which can be a burden even in a bad year. But debt decrease WACC and increase cost of equity as shareholder  demands more in return. So debt has two folding side.

For financing through gearing, it can increase shareholder wealth but it is too risky because Ke outweigh the extra debt (Kd) and the WACC rises and share price and shareholder wealth falls. There will be financial risks and bankruptcy risks if the firm finance too much in equity.

But it depend on the capital structure of each company. Some companies like to finance using equity because of illiquid assets but other through debt. Market industry that focus on retails chain or supermarkets suitable for debt finance because equity will be risky for them. But companies in related to banks or any share player like to used equity to finance their profit by attracting investors or sell share or buy share. Like Facebook that sells high shares to finance the business, attract investors and pay off their debts.