Optimal Capital Structure
OPTIMAL CAPITAL STRUCTURE is that mix of Debt and Equity which will maximize the market value of a company. Hence there should be a judicious combination of the various sources of long-term funds and short-term funds which provides a lower overall cost of capital and so a higher total market value for the capital structure can be attained.
Features of Optimal Capital Structure:
- 1.The relationship of debt and equity in an optimal capital structure is made in such a manner that the market value per equity share becomes maximum.
- 2. Optimal capital structure maintains the financial stability of the firm.
- 3. Under optimal capital structure the finance manager determines the proportion of debt and equity in such a manner that the financial risk remains low.
- 4.The advantage of the leverage offered by corporate taxes is taken into account in achieving the optimal capital structure.
- 5.Borrowings help in increasing the value of company leading towards optimal capital structure.
- 6.The cost of capital reaches at its minimum and market price of share becomes maximum at optimal capital structure
Constraints in Designing Optimal Capital Structure:
The capital structure of a firm is designed in such a manner that the cost of capital is kept at its lowest and the value of the firm reaches its maximum. The firm maneuvers its debt-equity proportion to reach the optimum level. However in practice, reaching the level of optimum capital structure is a difficult task due to several constraints that appear on the way of implementing that structure.
The main constraints in designing the optimum capital structure are:
- 1.The optimum debt-equity mix is difficult to ascertain in true sense.
- 2.The concept of appropriate capital structure is more realistic than the concept of optimum capital structure.
- 3.It is difficult to find an optimum capital structure as the extent to which the market value of an equity share will fall due to increase in risk of high debt content in capital structure, is very difficult to measure.
- 4.The market price of equity share rarely changes due to changes in debt-equity mix, so there cannot be any optimum capital structure.
- 5.It is impossible to predict exactly the amount of decrease in the market value of an equity share because market factors that influence market value of equity share are highly complex.
How we Add Value
Owing to our team’s experience in Banking and Lending to SME’s & Corporates, we have better understanding of almost all industries, their business cycles, their seasonality, competitor’s, value chain & business models. Using this domain knowledge, we create funding structures which ensures Adequate Liquidity, Optimum Funding Cost, Lower Gearing thru use of Vanilla / Hybrid Instruments. We also put emphasis on the Banker-Borrower Relationship to be like partners in growth. Bankers Provide Fuel to run Businesses & businesses provide opportunity to banks to deploy their money efficiently with optimal risk.
Invictus has always strived for optimum utilization of resources, and hence have created better funding structures. Few of our clients have been able to outsmart competition due to timely availability of financial resources.