Dr. Zulfiqar Hasan
Capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities.
Capital restructuring is a corporate operation that involves changing the mixture of debt and equity in a company's capital structure. It is performed in order to optimize profitability or in response to a crisis like bankruptcy, hostile takeover bid, or changing market conditions.
Motives of Capital Restructuring
- To enhance liquidity.
- To lower the cost of capital.
- To reduce risk.
- To avoid loss of Control.
- To improve Shareholder Value.
Capital Structure Theory
Capital Structure Theory refers to a systematic approach to financing business activities through a combination of equities and liabilities.
- Net Income Approach to Capital Structure Theory
- Net operating income approach
- Traditional approach (intermediate approach)
- Modigliani and Miller approach
- Pecking Order Theory
Modigliani and Miller (MM) Arguments
In a world of no taxes, the value of the firm is unaffected by capital structure.
Modigliani and Miller (MM) have a convincing argument that a firm cannot change the total value of its outstanding securities by changing the proportions of its capital structure. In other words, the value of the firm is always the same under different capital structures.
In still other words, no capital structure is any better or worse than any other capital structure for the firm’s stockholders.
Assumptions of the Modigliani-Miller Model
- Homogeneous Expectations
- Homogeneous Business Risk Classes
- Perpetual Cash Flows
- Perfect Capital Markets
- Perfect competition
- Firms and investors can borrow/lend at the same rate
- Equal access to all relevant information
- No transaction costs
- No taxes
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