Optimal Capital Structure. CPA Exam BAR скачать в хорошем качестве

Optimal Capital Structure. CPA Exam BAR

In this video, I explain the optimal capital structure. ✅https://farhatlectures.com/ 0:00 Introduction This video explains the concept of optimal capital structure, which is the best mix of debt and equity financing that minimizes a company's cost of capital and maximizes shareholder value (0:06). Key takeaways include: The cost of equity is generally higher than the cost of debt because equity holders take on more risk and are paid last in case of liquidation (2:48, 3:03). Debt is cheaper than equity for two main reasons: lenders are paid before equity holders, and interest payments on debt are tax-deductible, creating a "tax shield" that lowers the effective cost of debt (3:28, 3:50). While debt has benefits, too much debt increases a company's financial risk and the risk of financial distress or bankruptcy, which can raise the cost of both debt and equity (6:35, 8:13). The optimal capital structure balances the benefits of the debt tax shield with the costs of financial distress. Up to a certain point, adding debt can lower the overall cost of capital (Weighted Average Cost of Capital - WACC), but beyond that point, it starts to increase (7:22, 10:40). The video provides a numerical example illustrating how increasing debt can lead to a higher WACC if the associated risks cause the cost of debt and equity to rise significantly (13:39). CPA candidate or student? Start your free trial for more. The optimal capital structure of a company refers to the best mix of debt, equity, and other financing sources that minimizes the company's overall cost of capital and maximizes its value, i.e., the market value of its equity. The concept is based on the balance between the risk and the cost of capital. Here are the key components to understanding the optimal capital structure: 1. Cost of Capital: Cost of Equity: Equity holders expect a return on their investment, which is typically higher than the cost of debt since shareholders get paid after debt obligations are met. Cost of Debt: This is usually cheaper than equity because interest payments are tax-deductible, which lowers the effective cost, and creditors have a higher claim on assets and earnings than equity holders. A company's overall cost of capital is a weighted sum of the cost of debt and the cost of equity - the weights being the proportion of each in the company's capital structure. 2. Risk: Financial Risk: The more debt a company has, the greater its financial risk, or the risk that it won't be able to meet its debt obligations. Business Risk: The inherent risk in the company's operations; a company with stable cash flows may be able to support a higher debt load than one with volatile earnings. 3. Trade-Off Theory: This theory suggests there's a trade-off between the interest tax shields provided by debt financing and the costs of financial distress. Up to a certain point, the benefit of debt's tax shield outweighs the cost of financial distress. Beyond this point, additional debt increases the company's risk of financial distress disproportionately. 4. Pecking Order Theory: This theory posits that companies prioritize their sources of financing (from internal financing to equity) according to the principle of least effort, or least resistance, preferring to raise equity as a last resort. 5. Market Conditions: The condition of financial markets can affect a company's capital structure decision. For example, if the market is bullish on equity, a firm may issue stock to capitalize on higher valuations. 6. Company Specifics: Optimal capital structure can be influenced by: Tax rates: Higher tax rates favor debt due to the tax-deductibility of interest. Asset type: Companies with tangible assets can borrow more as they can use these assets as collateral. Growth opportunities: Companies with high growth prospects may rely more on equity to finance growth. 7. Modigliani and Miller Proposition: Economists Franco Modigliani and Merton Miller proposed that, in a perfect market, the value of a company is unaffected by its capital structure. However, they later incorporated tax effects into their theory, suggesting that because of the tax advantage of debt, companies should use debt financing up to the point where the tax benefit is equal to the cost of financial distress. Finding the Optimal Capital Structure: The optimal capital structure is thus company-specific and must be determined through analysis and balancing of these factors. It can change over time with the company's circumstances and with market conditions. Management may use various tools and models, including the weighted average cost of capital (WACC), to estimate the cost of different financing scenarios and find a structure that offers the best balance for the company’s specific situation.