Question

How would a financial manager determine optimal capital structure? Please give a detailed explanation. How this would fit in with the company's capital expenditures, growth plans and operating results? Please provide examples. Please keep in mind that inadequate answers that already exist on the web.

Answer 1

Finance manager will be determining the optimal capital structure of the company by going through the need of the company and also determining the cost of various types of capitals available in the market so it will be trying to go through all of the options available and the nature of the requirement and the past trends of the company so, he will be estimating the capital structure of the company after going through following-

A. He would be looking at cost of debt capital available in the market and if it is available at a cheap price, he will be selecting debt capital.

B. interest which are payable on debt capital are tax deductible in nature so he will be comparing the advantages associated with the debt capital with cost of financial distress which is also embedded that capital and he will be trying to find a balance between both of them.

C. He will also be trying to look at the flotation cost involved with the cost of equity and then decide upon the capital structure.

D. nature of the company and need of the company should also be looked into because some companies do not want dissolution of their equity so they will be prefering debt capital where as other companies are taking debt capital in order to expand themselves.

E. He will also be estimating the macrotrends which will be including inflation and interest rates into the economy in the future.

lower cost of capital will be helping the company's growth front to a higher extent and it will also be impacting the profit of the company because the lower cost of capital will be helping the company in order to establish a constant growth rate and it will also help the company in order to perform better on the operating front by reporting higher profits.

it can be exampled that a company which is looking for the growth will be placing higher amount of debt capital because the cost of debt is comparatively lower than the cost of equity and it would be leading to higher advantage because of difference in the growth rate and the cost of capital.