Question

Consider what you feel would be an optional capital structure.

a.Would your recommendation differ depending on the type of industry? Why/why not?

b.What would you expect the impact to be on earnings per share (EPS) at an optimal capital structure? Is this impact important to you? Why/why not?

Answer 1

Optimal capital structure is the one which minimizes the overall cost of capital and maxmizes the value of organization. at the same time it strikes a best balance between debt and equity. Capital can be raised either through equity or via debt. both has their own pros and cons.Debt usually acts as a chaeaper source of finance, however, it has the fixed payout to lenders even when profits are declining. Equity does not madate any payout to the holders, however, it entails the ownership.

A) Capital structure varies depending upon type of industry. capital intensive industry such as telecommunication needs more funds in Debt to cover their infrastructure and service committments. like for financial industry, the debt is much higher then ideal ratio of 2, reason being its their stock in trade kind of. they need money to lend further to customers.

B) EPS: earnings available to equityholders is directly impacted by the amount of debt a firm raises. more the amount of debt, lesser the amount of distributable profits for equity holders and lesser EPS. EPS is a parameter which drives the value of equity in market. the lesser the EPS, the lower would be market price of a share. as a shareholder, EPS is the most important parameter we look for. its definitely impacts the wealth of shareholder. However, for a debt holder impact on EPS would not matter. they get fixed payout on the amount lent to the company.