Answer to Question #41861 in Economics for jayashree

Question

What is meant by appropriate capital structure ? Discuss the determinants and features of an appropriate capital structure for a corporate body.

Answer 1

Appropriate capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or
hybrid securities. Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as long-term finance.

Features and determinants of an appropriate capital structure for a corporate
body:

1.Flexibility:
The consideration of flexibility gives the finance manager the ability to alter the
firm’s capital structure with a minimum cost and delay, if warranted by the
changed environment. It should also be possible for the company to provide
funds whenever needed to finance its profitable activities.

2.Profitability:
A sound capital structure should permit the maximum use of leverage at a minimum cost
so as to provide better profitability and thus maximizing earnings per share.

3. Solvency:
Extensive debt threatens the solvency and credit rating of the company. The debt
financing should be only to the extent that it can be serviced fully and also
be paid back (if required).

4.Conservatism:
No company should exceed its debt capacity. As already explained that the interest is to
be paid on debt and the principal sum is also to be paid. These payments depend
on future cash flows. If future cash flows are not sufficient then the cash
insolvency can lead to legal insolvency.

5. Control:
The capital structure should not lead to loss of control in the company.