Question

3. Global Communications is considering making a change to its capital structure to reduce its cost of capital and increase firm value. Right now, Global has a capital structure that consists of 20% debt and 80% equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6% and the market risk premium, rM − rRF, is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. What would be Global’s estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity? What is the importance of capital structure to a company and why? Please include excel cells and formulas

Answer 1

b. What is the importance of capital structure to a company and why?

Capital structure is essentially concerned with how the firm decides to divide its cash flows into two broad components,a fixed component that is earmarked to meet the obligations toward debt capital and a residual component that belongs to equity shareholders

Capital structure is the mix of the long-term sources of funds used by a firm. It is made up of debt and equity securities and refers to permanent financing of a firm. It is composed of long-term debt, prefer­ence share capital and shareholders’ funds.

The importance of designing a proper capital structure :-

Value Maximization

Cost Minimization

Increase in Share Price

Growth of the Country

Investment Opportunity

these are some important factors for why capital structure is important

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