Capital Structure

Capital Structure Policy
Target capital structure
Mix of debt, preferred stock, and common stock
Set equal to estimated 'Optimal Capital Structure'
Balances risk and return
Maximizes the firm’s stock price
Capital Structure Decisions
Ø Business risk
Ø Taxes
Ø Financial flexibility
Ø Managerial conservatism or aggressiveness
Ø Growth opportunities
EPS Indifference Analysis
Used to determine
'when debt financing is advantageous and when equity financing is advantageous'.
Can be illustrated graphically since the relationship between EBIT and EPS is linear.
"INDIFFERENT PIONT "
EPS (debt financing) = EPS (equity financing)




















Financial forecasting models
Can help show how capital structure changes are likely to affect stock prices, coverage ratios, and so on.
Can generate results under various scenarios, but the financial manager must specify appropriate input values, interpret the output, and eventually decide on a target capital structure.
"capital structure decision will be based on a combination of analysis and judgment".