Capital structure

Definition

Capital structure is the mix of debt and equity that a firm uses to finance its operations and growth. It directly impacts the company's risk, cost of capital, and overall financial strategy.

5 Must Know Facts For Your Next Test

1. Capital structure decisions involve balancing the trade-offs between debt and equity financing.
2. A higher proportion of debt in the capital structure can increase financial risk but may also provide tax advantages due to interest deductibility.
3. Equity financing involves issuing shares, which dilutes ownership but does not require fixed payments like debt.
4. The optimal capital structure minimizes the company’s cost of capital while maximizing its value.
5. Factors influencing capital structure include business risk, tax considerations, market conditions, and management style.

Review Questions

• What are the main components of a firm's capital structure?
• How does increasing debt in the capital structure affect a company's financial risk?
• What factors should managers consider when determining an optimal capital structure?

Related terms

Debt Financing: Raising funds for business activities by borrowing money that must be repaid with interest.

Equity Financing: Raising funds by selling ownership stakes in the company in the form of shares.

Cost of Capital: The rate of return required by investors to compensate them for the risk of investing in a company.