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Advantages Of Capital Structure Theory

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In financial management, capital structure theory is a systematic approach to financing business activities through a combination of equities and liabilities. By Competing capital structure theories explore the relationship between debt financing, equity financing and the market value of the firm.
Capital Structure is proportion of debt, preference and equity capitals in the total financing of the firm’s assets. The main objective of financial management is to maximum the value of the equity shares of firm. Given this objective, the firm has to choose that financing mix/capital structure which results in maximize the wealth of the equity shareholders. This type of capital structure is called as the optimum capital structure. In the optimum …show more content…

If internal funds are deficiency to finance investment opportunities, a company should obtain external financing but it will choose from the various external finance sources in a manner as to minimize additional costs. This theory regards the market-to-book ratio as a way to measure investment opportunities. This theory is made famous by Myers and Majluf as he claims that equity is a significantly less favored way to raise capital because when managers issue fresh equity, investors feel that managers think that the company is overvalued and managers are taking advantage of this over-valuation. Because of this, investors will place a diminish value to the new equity …show more content…

As a result, variations in stock prices influence firm’s capital structures. Companies don’t usually care whether they finance with debt or equity; they simply took the type of financing which, at that point in time, appears to be more valued by financial markets.
The market timing hypothesis is a theory of how firms and corporations in the economy decide whether to finance their investment with equity or with debt instruments. Market timing is the first order determinant of a corporation 's capital structure use of debt and equity. In different words, firms do not generally care whether they finance with debt or equity; they just choose the form of financing which, at that point in time, seems to be more valued by financial market.

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