The capital structure decision can affect the value of the firm either by changing the expected earnings or the cost of capital or both. The objective of the firm should be directed towards the maximization of the value of the firm the capital structure, or average, decision should be examined from the point of view of its impact on the value of the firm. If the value of the firm can be affected by capital structure or financing decision a firm would like to have a capital structure which maximizes the market value of the firm. If average affects the cost of capital and the value of the firm, an optimum capital structure would be obtained at that combination of debt and equity that maximizes the total value of the firm value of shares plus value of debt or minimizes the weighted average cost of capital.
Here, I have made these theories simplified. One is share capital and other is Debt.
Now, I am ready to explain these four theories of capital structure in simple and clean words. A firm can choose a degree of capital structure in which debt is more than equity share capital. It will be helpful to increase the market value of firm and decrease the value of overall cost of capital.
Debt is cheap source of finance because its interest is deductible from net profit before taxes. After deduction of interest company has to pay less tax and thus, it will decrease the weighted average cost of capital.
For example if you have equity debt mix is High debt content mixture of equity debt mix ratio is also called financial leverage. It means to change the capital structure does not affect overall cost of capital and market value of firm. At each and every level of capital structure, market value of firm will be same.
It has three stages which you should understand: Ist Stage In the first stage which is also initial stage, company should increase debt contents in its equity debt mix for increasing the market value of firm.
So, no need to further increase in debt in capital structure. This approach says that there is not any relationship between capital structure and cost of capital.
There will not effect of increasing debt on cost of capital.North South University is the first private university of Bangladesh, was established in A Review of Empirical Capital Structure Research 5 in all settings; rather, the original theory is geared towards mature, low growth-option ﬁrms.
More generally, a given market friction may be a ﬁrst-order concern for some types of ﬁrms. Circular economy – From review of theories and practices to development of implementation tools. three major theories of capital structure emerged which diverge from the assumption of perfect capital markets under which the “irrelevance model” is working named as Trade Off theory, Pecking Order theory and later Market Timing theory (Luigi & Sorin, ).
A REVIEW OF THE CAPITAL STRUCTURE THEORIES Popescu Luigi Universitatea Pitesti, Facultatea de Stiinte Economice, Str Republicii, Nr 71, Pitesti Email. The capital structure decision can affect the value of the firm either by changing the expected earnings or the cost of capital or both.
The objective of the firm should be directed towards the maximization of the value of the firm the capital structure, or average, decision should be examined from.