Capital Structure, What gives?

SG 88
2022-07-12

A Company’s Capital Structure refers to the mixture of equity and debt financing leveraged to finance its assets. Such mixture of equity and debt capital is consider as financing decision.

Such financing decision would have direct effect to the weighted average cost of capital (WACC). With that in mind, any changes to the financing decision, would undoubtedly effect WACC.

In any given organisation, the objective is surely to maximise shareholder wealth. To determine the wealth, is the measurement of future cash flows discounted at investors’ required return, ie WACC.

The Present Market Value of a Company = Future Cash Flows / WACC

Example:

100 / 0.15 = 667

100 / 0.10 = 1,000

Therefore, looking for higher shareholder wealth = searching for lowest WACC.

Questions: Which would be ideal blend between equity and debts?

Debts Financing

  1. Debt financing often the repayment amount is fixed in nature
  2. Repayment is obligation in nature
  3. In the event of liquidation, debt holders would receive their capital repayment before shareholders
  4. In Corporate tax treatment, Interest is prioritise given that interest is deducted before tax is calculated (Tax relief) Vs Dividend which is calculated after Tax deduction

Of course the higher Interest repayment (higher gearing) meaning lesser profit would be distributed to shareholders via dividends.

Given the volatility of Interest Rate Hike by the Feds, shareholders would require higher returns to hedge against such financial risk.

What would you consider an ideal balance mix of equity and debts financing for a company of your choice?

@TigerStars @MillionaireTiger @Tiger_Academy 

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Comments

  • Johnnych
    2022-08-10
    Johnnych
    股市是领导说的算,他们是制定游戏规则的人
    • SG 88
      说的没错 [Cool]
  • Kelvink73
    2022-07-12
    Kelvink73
    debt the lesser the better, unless it can generate return much higher than interest paid.
  • MZ39
    2022-07-12
    MZ39
    excellent post! tks for sharing
  • Watermelonman
    2022-12-15
    Watermelonman
    what is the common paratice of ideal balance mix of equity and debt balancing ?
    • WatermelonmanReplySG 88
      thanks for the info
    • SG 88
      I guess it's depends on your risk appetites as well as your investment period. Long term, equity is preferred, whereas for short term, a mixture of 60 to 70 equity with 40 to 30 in debts [Happy]
  • Newnew
    2022-07-12
    Newnew

    Thank 

  • Richest Princess
    2022-09-14
    Richest Princess
    thanks,  great 👍
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