MBA assignments of MB0029 for Financial Management
Question - Describe the factors for designing an ideal capital structure of a company.
Answer - Designing an ideal capital structure it requires a number of factors to be considered such as:
Return: The capital structure of a company should be most advantageous. It should generate maximum returns to the shareholders for a considerable period of time and such returns should keep increasing.
Risk: As already disused in the various chapter on-leverage, use of excessive debt funds may threaten the company’s survival. Debt does increase equity holders’ returns and this can be done till such time that no risk is involved.
Flexibility: The Company should be able to adapt itself to situations warranting charged circumstances with minimum cost and delay.
Capacity: The capital structure of the company should be within the debt capacity. Debt capacity depends on the ability for funds to be generated. Revenues earned should be sufficient enough to pay creditors interests, principal and also to shareholders to some extent.
Control: An ideal capital structure should involve minimum risk of loss of control to the company. Dilution of control by indulging in excessive debt financing is undesirable. With the above points on ideal capital structure, rising funds at the appropriate time to finance firm’s investment activities in an important activity of the finance manager. Golden opportunities may be lost for delaying decisions to this effect.
A company nation of debt and equity is used to fund these activities. What should be the proper of debt and equity? This depends on the cots associated with raising various categories of investors who have made investment in the form at loans, debentures, equity and preference of shares.
A company no being able to meet these demands may face the risk of investors taking back their investments thus leading to bankruptcy. Loans and debentures come with a pre-determined interest rate, preference shares also have a fixed rate of dividend while equity holders expect a minimum return of dividend based on their risk perception and the company’s past performance in returns terms of pay-out of dividends.