The Capital Structure Decision and the Cost of Capital
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The paper explains that the goal of any company is to develop a capital structure that will allow them to have the best debt to equity proportions in order to aid them in being successful. The paper discusses how when determining the proper capital structure for a company, it is important to look at the nature of the business that they are in, the riskiness of their business and the advantages and disadvantages of debt over equity financing. The paper uses these criteria to examine Ford, Disney and Electronic Arts.and to recommend a capital structure that is most suitable for each business.
From the Paper:"The best way to think about a most favorable firm structure is that the current owners of a firm are thinking about how to sell their firm today. Their goal is to design a corporate charter that maximizes the total market-value of their firm today, that is the price that new investors will be willing to pay to acquire the firm from the old investors. The corporate charter must not only specify the voting rules, the procedure to replace incumbent managers and how the charter can be changed in the future, but also how future earnings are to be split among different owners (such as bondholders and stockholders) and stakeholders1 (such as customers, workers, and suppliers). The agreement how to split up future earnings -either explicitly outlined or implicitly allowed to be changed in the future -is the firm's financial structure: rules that specify who receives the proceeds of (possibly uncertain) future cash flows (Welch, 1996).
"Traditionally, corporations have used bonds and stocks (equity). Generally, bonds (leverage) are like loans, promising certain payoffs. Equity is like ownership, receiving whatever is left over after the promises to bondholders have been honored. In addition, modern corporations can use a variety of financial instruments that promise different future payoffs to various buyers under various scenarios: convertible debt, equity, warrants, derivatives, leases, trade credit. Firms can also pool assets and borrow from banks (Welch, 1996)."
Sample of Sources Used:
- Blueprint for Sustainability The Future at Work. (2010). Retrieved September 9, 2010, from Web site: http://www.ford.com/doc/sr09-blueprint-summary.pdf
- Debt vs. Equity -- Advantages and Disadvantages. (2010). Retrieved September 9, 2010, from Find Law Web site: http://smallbusiness.findlaw.com/banking_financing/be1_5debtvsequity.html
- Electronic Arts Hits Dead End, Makes Strategic UsdTurn (ERTS). (2009). Retrieved September 9, 2010, from Investor Guide Web site: http://www.investorguide.com/article/534/electronic-arts-hits-dead-end-makes-strategic- usdturn-erts/
- Fitch Assigns 'A' Rating to Disney's Proposed Note Offering. (2008). Retrieved September 9, 2010, from Web site: http://www.thefreelibrary.com/Fitch+Assigns+%27A%27+Rating+to+Disney%27s+Prop osed+Note+Offering.-a0190760761
- Fitch Raises Ford's Default Risk Rating. (2010). Retreived September 9, 2010, from ABC News Web site: http://abcnews.go.com/Business/wireStory?id=9534721
Cite this Term Paper:
The Capital Structure Decision and the Cost of Capital (2013, April 29) Retrieved April 21, 2021, from https://www.academon.com/term-paper/the-capital-structure-decision-and-the-cost-of-capital-152785/
"The Capital Structure Decision and the Cost of Capital" 29 April 2013. Web. 21 April. 2021. <https://www.academon.com/term-paper/the-capital-structure-decision-and-the-cost-of-capital-152785/>