like affording flexibility, control, etc. adaptable framework for any company.

Capital Structure and Value of a Firm

This is to provide a general

We know that there are two main sources of finance available for a company (or a firm) such as debt and equity. However it is difficult to arrive at the exact or at least optimum proportion of debt and equity in the capital structure of a company. Therefore, ascertaining the level of financial leverage is the primary task to be performed. The main objective of financial management is to maximize the owners (share holders) wealth and value. The key issues are the relationship between capital structure and cost of capital. We know given a certain level of earnings, the value of the company is maximized when the cost of capital is minimized. In the same vein the value of the company is minimized when the cost of capital is maximized. Therefore the value of the company and the cost of capital are inversely related. There are many different arguments and view points as to how the capital structure influences the value of the company. Some argue that financial leverage (use of debt capital) has a positive effect on the company value up to a point and negative thereafter. On the other extreme, few contend that there is no relation between capital structure and value of the company. Many strongly believe that other things being equal, greater the leverage, greater will be the value of the company The capital structure of a company will be planned and implemented when the company is formed and incorporated. The initial capital structure would therefore be designed very carefully. The management of a company would set a target capital structure and the subsequent financing decisions would be made with a view to achieve the target capital structure. The management has also to deal with an existing capital structure. The company will need to fund or finance its activities continuously. Every time a need arises for funds, the management will have to weigh the pros and cons of the various sources of finance and then select the advantageous source keeping in view the target capital structure.

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