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    Debt and Capital Structure

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    Should a company be financed entirely with debt? Why or why not? How does debt impact the optimal capital structure?

    © BrainMass Inc. brainmass.com June 3, 2020, 8:07 pm ad1c9bdddf
    https://brainmass.com/business/capital-structure-and-firm-value/124780

    Solution Preview

    A firm's long-term success depends upon the firm's investments earning a sufficient rate of return. This sufficient or minimum rate of return necessary for a firm to succeed is called the cost of capital. The cost of capital can also be viewed as the minimum rate of return required keeping investors satisfied.

    Thus the objective of the capital structure management is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). It has to optimally utilize the sources of finances which broadly are equity and Debt. The advantages of each are described below:

    Issue of Equity Shares
    Equity can be raised either by private placement or by public. Intel has got strong track record; thus it can use this route to raise money. It has following features:
    Claim on Income and Assets:
    Shareholders have the claim on income and assets of the firm.
    Right to Control
    Voting Rights
    Pre-Emptive Rights
    Limited Liability
    Advantages of raising shares
    Permanent Capital: It need not be paid back
    Borrowing Base: It can be used to trade on equity
    Dividend Payment Discretion: The payment of dividend is in the hands of management

    Disadvantages
    Cost: It is more costly than debt
    Earnings Dilution: It involves reduction in EPS.
    Ownership Dilution: It involve sharing of ...

    Solution Summary

    The solution discusses the relationship between debt and capital structure for a firm.

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