The Size Of Corporations And Capital Structre

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02 Nov 2017

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CAPITAL STRUCTURE

Introduction

As we know that capital structure are important for firms to start and build their investment in financial markets or any markets as mortgage market, so it's need for a structure organized well and these structure influence by many factors.

Definition of 'Capital Structure’:

A mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds.

Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure.

1-THE SIZE OF CORPORATIONS AND CAPITAL STRUCTRE

The size of corporations when it be large the capital structure will be complicated why? Cause large one have more long debt and more equity and sure high profits.

Firm size has a positive impact on leverage consistent with the predictions of trade-off theory

2-PROFITABILITY AND CAPITAL STRUCTER

Profitability when corporations depend on high debt to equity the profit it will decline why? Interest paid is higher.

An appropriate mix of capital structure should be

adopted in order to increase the profitability of

Corporations Findings revealed that total debt is

Negatively correlated to the net profit (R=X)

In this case of higher debt, profitability will tend to decline. The reason behind this may be due to the high interest bearing securities engaged in the total debt.

In addition to these an increase in the level of debt also increases the riskiness of corporations. Therefore corporations should concern much on internal sources of financing in order to increase their profitability.

Profitability is negatively associated with the leverage, and is consistent with the predictions of pecking-order Theory. The coefficient estimate of (X), Implies that, for a 1 percent increase in the earnings before interest and taxes, relative to total assets, the debt equity

Ratio of firm will decline by about (X %) percent.

3-THE NONDEBT TAX SHIELDS

Definition of 'Tax Shield’:

A reduction in taxable income for an individual or corporation achieved through claiming allowable deductions such as mortgage interest, medical expenses charitable donations, amortization and depreciation. These deductions reduce taxpayers' taxable income for a given year or defer income taxes into future years.

Tax shields vary from country to country, and their benefits will depend on the taxpayer's overall tax rate and cash flows for the given tax year.

The non-debt tax shields (NDTS) are positively related to leverage contrary to the predictions of trade-off theory.

However, the positive association between NDTS and leverage, one possible explanation for this finding may be that expected income streams

Of corporations, against which interest expenses and NDTS (depreciation), can be deducted are very high as compared to the total of debt and non-debt tax deductions therefore, depreciation does not work as a substitute to the tax benefits of debt financing firms the regression co-efficient

That for a 1 percent increase in depreciation (NDTS) firms debt-equity ratio will increase by about X Percent.

4-THE TANGIBILITILY OF ASSETS

Tangibility or collateral value of assets is estimated to have positive impact on leverage.

This result indicates that with a 1 percent increase in the

Firm s collateral sable assets, relative to total assets, there is 0.1849 percent rise in debt-equity ratio or leverage ratio of firm.

5-MARKET TO BOOK RATIO

Many corporate financing decisions depend on market valuations. Firms tend to issue equity instead of debt when market value is high, relative to book value and past market values, and repurchase equity when market value is low. These relationships are robust enough to be counted among the stylized facts of corporate finance capital structure depends strongly on past market valuations as measured by past market-to-book ratios. The mechanics of this relationship are simple. Capital structure is the cumulative outcome of past financing decisions. Past financing decisions depend strongly on past market valuations. Therefore capital structure depends strongly on past market valuations.

Empirically speaking, the most useful way to summarize past market valuations seems to be the external finance weighted average market-to-book ratio. This is a weighted average of past market-to-book ratios where the weights are the corresponding levels of external finance –equity plus debt. We find that the weighted average is strongly positively related to the equity-to assets ratio, even controlling for contemporaneous levels of market-to-book. In other words, temporary fluctuations in value can induce permanent changes in capital structure.

The tradeoff and pecking order theories of capital structure offer potential explanations for our main finding, but both theories fail to deliver on key ancillary predictions. An ancillary prediction of the tradeoff theory is that the influence of temporary fluctuations in market-to-book

Should disappear however, an ancillary prediction of the pecking order is that firms only raise external finance when

They have plans for the proceeds however, the extra cash raised when market values are temporarily high increases cash balances to a level that is maintained for at least a decade.

In the end good past book ratio market for firm is positive to capital structure.

6-Addition factor is THE GROWTH

The relationship between leverage and growth in total assets is found to be negative, and is consistent with the predictions of trade-off theory and indicates that growing corporations rely less on debt and more on internal funds (retained Earnings) or equity to finance their fresh investment opportunities.

Hypothesis

Factor relation

Firm size + (trade of theory)

- (pecking order)

Profitability + (trade of theory)

- (pecking order)

Tangibility + (trade of theory)

+ (pecking order)

NDTS - (trade of theory)

Market to book ratio + (trade of theory)

+ (pecking order)

Growth - (trade of theory)

+ (pecking order)



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