Learning Unit/Chapter 12: Capital Structure
Sources of financing:
Debt Equity
Types of financing
Long term financing (5 years or longer) Ordinary shares
Bonds Higher risk and thus higher return
Debentures Used in WACC
Loan Preference shares
Lower risk than ordinary shares
Medium term financing (between 1 and 5 WHY?
years) - Fixed % dividend
→ Overdraft - Preference @ liquidation
→ Leases
→ Sale and leaseback
Short term financing (less than a year)
Working capital management
Cheaper than equity
Why?
- Less risk – formal contract guarantees
payment
- Tax benefit
Balance between these two
Capital structure = % debt and % equity
Point where WACC is lowest according to traditional
theory of gearing
Debt – cheaper – get more debt and decrease WACC up to a certain point; higher return for
shareholders
Too much debt – more interest – higher WACC and lower return
Sources of financing:
Debt Equity
Types of financing
Long term financing (5 years or longer) Ordinary shares
Bonds Higher risk and thus higher return
Debentures Used in WACC
Loan Preference shares
Lower risk than ordinary shares
Medium term financing (between 1 and 5 WHY?
years) - Fixed % dividend
→ Overdraft - Preference @ liquidation
→ Leases
→ Sale and leaseback
Short term financing (less than a year)
Working capital management
Cheaper than equity
Why?
- Less risk – formal contract guarantees
payment
- Tax benefit
Balance between these two
Capital structure = % debt and % equity
Point where WACC is lowest according to traditional
theory of gearing
Debt – cheaper – get more debt and decrease WACC up to a certain point; higher return for
shareholders
Too much debt – more interest – higher WACC and lower return
