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  • Capital Structure Theories Assumptions

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    Kamala Kris
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    The capital structure theories make several assumptions: firms only use perpetual debt and equity financing, pay out all earnings as dividends with no retained earnings, have fixed total assets and investment levels, constant business risk independent of capital structure, operate indefinitely with stable non-growing earnings, and can alter leverage over time by changing debt and equity levels while maintaining total financing. All investors are also assumed to have identical views of firms' future profitability.

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    The capital structure theories make several assumptions: firms only use perpetual debt and equity financing, pay out all earnings as dividends with no retained earnings, have fixed total assets and investment levels, constant business risk independent of capital structure, operate indefinitely with stable non-growing earnings, and can alter leverage over time by changing debt and equity levels while maintaining total financing. All investors are also assumed to have identical views of firms' future profitability.

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    3K views1 page

    Capital Structure Theories Assumptions

    Uploaded by

    Kamala Kris
    The capital structure theories make several assumptions: firms only use perpetual debt and equity financing, pay out all earnings as dividends with no retained earnings, have fixed total assets and investment levels, constant business risk independent of capital structure, operate indefinitely with stable non-growing earnings, and can alter leverage over time by changing debt and equity levels while maintaining total financing. All investors are also assumed to have identical views of firms' future profitability.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as TXT, PDF, TXT or read online from Scribd
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    Generally, the capital structure theories have the following assumptions:

    There are no corporate taxes (this assumption has been removed later).
    The firms use only 2 sources of financing namely perpetual debts ad equity share
    s
    The firms pay 100% of the earnings as dividend. This means that the dividend pay
    -out ratio is 100% and there are no earnings that are retained by the firms.
    The total assets are given which do not change and the investment decisions are
    assumed to be constant.
    Business risk is constant over time and it is assumed that it is independent of
    the capital structure.
    The firm has a perpetual life.
    The firm s earnings before interest and taxes are not expected to grow.
    The firm s total financing remains constant. The firm s degree of leverage can be al
    tered either by selling shares and to retire the debt using the proceeds or by r
    aising more debt and reduce the equity financing.
    All the investors are assumed to have the same subjective probability distributi
    on of the future expected operating profits for a given firm.

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