Capital Structure and Growth Needs
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What considerations might a growing firm have in its capital structure to fund growth needs?
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Solution Summary
This solution of 692 words looks are factors a firm needs to take into account in its capital structure to fund growth needs and justifies each choice. It discusses concepts of WACC, cost of debt, revenue, capital market and others. References used are included.
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A growing firm's requirement for the funds will be high in order to expand rapidly. It must consider the objective of the capital structure management which is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC).
Factors which go in determining right mix:
The Nature of Agency Cost of Debt
The agency cost of debt is associated with monitoring, enforcing, credibly promising, and constraining decisions, and result from the general situation in which the optimization problem for one constituency is suboptimal for another constituency. In terms of the agency costs of debt, Jensen and Meckling (1976) suggest that the potential conflict between equity and debt claimants is presented primarily in terms of wealth expropriation and risk shifting.
Shareholders may capture wealth from bondholders by investing in new projects that are riskier than those presently held in the firm's portfolio. If the projects perform well, shareholders capture most of the gains, while bondholders bear most of the cost (Fama and Miller, 1972). The fact that shareholders of a ...
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