Question

identify the two capital structure issues that financial managers must address and explain the effects and significance of these issues.

Answer 1

Capital structure :-

Meaning - It is the combination of debt and equity both can be found in the balance sheet used by a company to finance its operations and growth.

Capital structure issues -

- Financial debt-to-asset ratio

- Issuing activity vs leverage changes

Financial debt-to-asset ratio - It is the sum total of debt relative to asset owned by a company. Under it, comparison of one company leaverage is done with the other company of the same industry.

formula to calculate the ratio is short-term debt plus long-term debt is divided by total assets.

Effect - If the ratio is high, risk of investment in that company is also high and vice versa.

Significance - 1. It tells whether the company has enough funds to meet its current debt obligation or not.

2. Creditors use these ratio to calculate how much debt the company already has and whether the company can repay its existing debt.

Issuing activity vs leverage changes - It can be defined as the ability of a company to meet its financial obligations and Common leverage ratios are debt-to-equity ratio, equity multiplier etc.

formula to calculate debt-to-equity ratio is total liabilities divided by total shareholders equity.

Effect - High debt-to-equity ratio tells that a company has been aggressive in financing its growth with debt.

Significance - it is used to measure a company's mix of operating expenses to know how changes in output will affect operating income.

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