Question

What is the rationale for a company to take on more debt than stock from a stock valuation perspective? Please advise in detail. Three or four paragraphs should suffice

Answer 1

Capital structure

Capital structure refers to the mix of a company's capitalisation. That is a a mix of long term sources of funds such as debentures, preference share capital, equity share capital and retained

earnings. It is for meeting the total capital requirement.

While choosing a suitable Capital structure various factors are taken into consideration by financial managers like cost, risk, control, competition in the industry, Flexibility, taxation.

The decision in relation to the financing of firms assets is very crucial in every business. The financial manager is often in a dilemma to choose the optimum portion of debt and equity.

When Taxation is high- Then firms generally prefer to choose debt as an ideal source of Capital because they get tax benefits from the use of debt.

The interest/ coupon Payments to Bondholders are tax-deductible. As it is a payment made to an outsider. The firm needs to deduct income tax and pay it.

They provide tax shield to The firm. Hence encouraging the use of debt.

When Taxation is low- The firms generally prefer equity as a source of Capital.

capital structure are made by financial managers so as to:

1. Value maximization of the company.

2. Cost minimization.

3. Growth of the company increases.

4. Increase in the share price.