Optimal Capital Structure :
Optimal Capital Structure The optimal or the best capital structure implies the most economical and safe ratio between various types of securities.
It is that mix of debt and equity which maximizes the value of the company and minimizes the cost of capital.
Characteristics of optimal capital structure:- :
Characteristics of optimal capital structure:- Simplicity
Low cost
Maximum return & minimum risk
Maximum control
Liquidity
Flexibility
Equitable capitalization
Optimum leverage
Pattern of capital structure :
Pattern of capital structure Exclusive equity
Equity & preferred stock
Equity & bonds
Equity, bonds & preferred stock
Capital structure decision factors :
Capital structure decision factors
Internal Factors :
Internal Factors Size of Business
Nature of Business
Regularity and Certainty of Income
Assets Structure
Age of the Firm
Desire to Retain Control
Future Plans
Operating Ratio
Trading on Equity
Period and Purpose of Financing
External Factors :
External Factors Capital Market Conditions
Nature of Investors
Statutory Requirements
Taxation Policy
Policies of Financial Institutions
Cost of Financing
Seasonal Variations
Economic Fluctuations
Nature of Competition
Basic Ratio :
Basic Ratio Sound or Optimal Capital Structure requires (an approximation):-
Debt Equity Ratio: 1:1
Earning Interest Ratio: 2:1
During Depression: one and a half time of interest.
Total Debt Capital should not exceed 50 % of the depreciated value of assets.
Total Long Term Loans should not be more than net working capital during normal conditions.
Current Ratio 2:1 and Liquid Ratio 1:1 be maintained.