Topic Report-Capital Structure Provide your discussion for the following questio

Question

Topic Report-Capital Structure Provide your discussion for the following questions. For clarification, at least a couple of paragraphs of writing is required for each question 1. Explain the financial risk in terms of firm capital structure. What s the relationship between financial risk and required return of equity? 2. In each of the theories of capital structure, the cost of equity increases as the amount of debt increases. So why don't financial managers use as little debt as possible to keep the cost of equity down? After all, aren't financial managers supposed to maximize the value of a firm? 3. Explain when the optimal capital structure is achieved according to the Trade-Off 4. In view of the Pecking Order theory, why equity ranks at the bottom in capital 5. List at least three determinants of capital structure in empirical literature. theory. financing?

Explanation / Answer

1.

Capital structure decision is based on tradeoff theory. the tradeoff between level of risk and overall cost of capital/ there is two main part of capital structure that is debt and equity.  when company use more debt the probability of bankruptcy increase. Financial risk is type of risk of company that arise when debt capital in capital structure increase. when debt increase in capital structure then risk of bankruptcy increase and so financial risk odf company increase.

When financial risk of company increase then cost of equity will also increase. when risk increase then investor require more return on investment.

2.

Capital structure decision is based on tradeoff theory. the tradeoff between level of risk and overall cost of capital/ there is two main part of capital structure that is debt and equity. the cost of debt is usually less and interest payment on debt capital is deductible from taxable income. So, if company use more debt than overall cost of capital of company reduced.

At the same time when company use more debt the probability of bankruptcy increase. so, the manager must tradeoff between bankruptcy risk and cost of capital while making decision about capital structure.

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