Question

How do changes in capital structure affect a firm's value?

Answer 1

Changes in capital structure will be affecting the overall form value because-

A.there is different cost of equity and cost of debt associated with the overall capital structure of the company and any change in their proportion would be impacting the overall value of the company because they are having a cost associated with them

B.debt financing is generally associated with interest rate tax shield because the interest payment of tax deductible in nature and show an increase in the use of more debt capital will be leading to lesser cost to the firm

C. flotation cost are often involved with the cost of equity and they are going to increase the overall cost of the firm so it will reduce the value of the company

D. excessive use of debt capital will be leading to cost of financial distress and risk of insolvency of the firm so it will also reduce the value of the company.

E .when the return on capital which is generated by the company is higher than the overall cost of debt, and the differential between them will be helpful for the company in order to maximize the rate of return and thereby maximizing the overall value of the company.

So it can be summarised that the value off company is directly determined by the use of the capital structure.