The Target Capital Structure

Firms can choose whatever mix of debt and equity they desire to finance their assets, subject to the willingness of investors to provide such funds. And, as we shall see, there exist many different mixes of debt and equity, or capital structures - in some firms, such as Chrysler Corporation, debt accounts for more than 70 percent of the financing, while other firms, such as Microsoft, have little or no debt.

In the next few sections, we discuss factors that affect a firm's capital structure, and we conclude a firm should attempt to determine what its optimal, or best, mix of financing should be. But, you will find that determining the exact optimal capital structure is not a science, so after analyzing a number of factors, a firm establishes a target capital structure it believes is optimal, which is then used as a guide for raising funds in the future. This target might change over time as conditions vary, but at any given moment the firm's management has a specific capital structure in mind, and individual financing decisions should be consistent with this target. If the actual proportion of debt is below the target level, new funds will probably be raised by issuing debt, whereas if the proportion of debt is above the target, stock will probably be sold to bring the firm back in line with the target debt/assets ratio.

Capital structure policy involves a trade-off between risk and return. Using more debt raises the riskiness of the firm's earnings stream, but a higher propor- tion of debt generally leads to a higher expected rate of return; and, we know that the higher risk associated with greater debt tends to lower the stock's price. At the same time, however, the higher expected rate of return makes the stock more attractive to investors, which, in turn, ultimately increases the stock's price. Therefore, the optimal capital structure is the one that strikes a balance between risk and return to achieve our ultimate goal of maximizing the price of the stock.

Four primary factors influence capital structure decisions:

1. The first is the firm's business risk, or the riskiness that would be inherent in the firm's operations if it used no debt. The greater the firm's business risk, the lower the amount of debt that is optimal.

2. The second key factor is the firm's tax position. A major reason for using debt is that interest is tax deductible, which lowers the effective cost of debt. However, if much of a firm's income is already sheltered from taxes by accelerated depreciation or tax loss carryforwards, its tax rate will be low, and debt will not be as advantageous as it would be to a firm with a higher effective tax rate.

3. The third important consideration is financial flexibility, or the ability to raise capital on reasonable terms under adverse conditions. Corporate treasurers know that a steady supply of capital is necessary for stable operations, which, in turn, are vital for long-run success. They also know that when money is tight in the economy, or when a firm is experiencing operating difficulties, a strong balance sheet is needed to obtain funds from suppliers of capital. Thus, it might be advantageous to issue equity to strengthen the firm's capital base and financial stability.

4. The fourth debt-determining factor has to do with managerial attitude (conservatism or aggressiveness) with regard to borrowing. Some managers are more aggressive than others, hence some firms are more inclined to use debt in an effort to boost profits. This factor does not affect the optimal, or value- maximizing, capital structure, but it does influence the target capital structure a firm actually establishes.

These four points largely determine the target capital structure, but, as we shall see, operating conditions can cause the actual capital structure to vary from the target at any given time. For example, as discussed in the Managerial Perspective at the beginning of the chapter, the debt/assets ratio of Unisys clearly has been . much higher than its target, and the company has taken some significant correc- tive actions in recent years to improve its financial position.

Analia Jones is a Business Developer Manager of http://www.my-mortgege-loans.co.uk
http://www.my-mortgege-loans.co.uk
http://www.my-mortgege-loans.co.uk

to o hare transportation Riverwoods .. Lockport Chicago limo O’Hare

In The News:

Kurt the CyberGuy walks through steps he recommends immediately taking after getting new electronics — like phones or TVs — as gifts this holiday season.

When speaking becomes physically challenging, you can preserve your unique voice using Apple's Personal Voice and Live Speech technology.

Google Maps is deleting location history soon. Tech expert Kurt “CyberGuy" Knutsson shows you how to back it up before it's gone.

iOS 18.2 lets AirTag owners securely share item locations with trusted individuals. Tech expert Kurt “CyberGuy" Knutsson examines the powerful new feature.

The FBI is warning timeshare owners of a telemarketing scam tied to a Mexican drug cartel. Tech expert Kurt “CyberGuy" Knutsson provides steps to stay safe.

Protecting your home network includes securing your router, just like your phone or laptop. Kurt “CyberGuy" Knutsson reveals six ways to protect your Wi-Fi router from hackers.

Kurt “CyberGuy" Knutsson: ConnectOnCall breach leaks sensitive data of 910,000+ patients.

Rising elder scams: How to recognize them and protect yourself and your loved ones. Tech expert Kurt “CyberGuy" Knutsson helps you outsmart the scammers.

There are common habits and oversights that could leave your financial information vulnerable to cybercriminals, according to Kurt the CyberGuy.

Counting calories just got easier with The Drop, the world's first automated nutrition tracker using advanced computer vision and artificial intelligence.

A virtual private network can help ensure your information remains security and your privacy remains intact. Kurt the CyberGuy explains.

Stay up to date on the latest AI technology advancements and learn about the challenges and opportunities AI presents now and for the future.

Artificial intelligence-based cameras are giving air defense operators unprecedented capabilities in monitoring and protecting airspace.

Apple's iOS 18.1 Inactivity Reboot automatically reboots your iPhone if it hasn't been used or unlocked for more than three days, providing better data protection.

An inventor designed rooftop solar panels for a Tesla that draws solar energy while the car is parked, adding travel mileage without plugging in.

There are currently no laws governing what artificial intelligence can and cannot do with the information it gathers; here are 10 things to avoid telling AI chatbots to keep yourself safe.

A credit union with over 240,000 members recently revealed it was targeted by cybercriminals, resulting in a data breach that was part of a two-month attack by hackers.

Scammers have become skilled at creating convincing fake websites that can easily fool unsuspecting users. The CyberGuy offers tips to protect yourself.

Stay up to date on the latest AI technology advancements and learn about the challenges and opportunities AI presents now and for the future.

CAPTCHAs, which are used by websites to confirm whether users are people or bots, are harmless, but hackers are using them to infect PCs with malware.

Hackers recently leaked personal information of about 500,000 Americans and stole patient medical records that included lab results and insurance details.

The holiday season sees a rise in mobile shopping scams. Tech expert Kurt “CyberGuy" Knutsson helps you learn how to stay safe.

Tech expert Kurt “CyberGuy" Knutsson says a VPN enhances online banking security by encrypting data and protecting privacy.

Beware of these six sneaky holiday scams. Tech expert Kurt “CyberGuy" Knutsson gives you tips to avoid falling victim.

Tech expert Kurt “CyberGuy" Knutsson reveals how to securely back up and factory reset your Android to protect your privacy and data.

The Target Capital Structure

Structured Settlements