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Hi, I need help with essay on CORPORATE FINANCE. Paper must be at least 1500 words. Please, no plagiarized work!It had been generally assumed that there is an optimal mixture of debt and equity in a f
Hi, I need help with essay on CORPORATE FINANCE. Paper must be at least 1500 words. Please, no plagiarized work!
It had been generally assumed that there is an optimal mixture of debt and equity in a firm's capital structure that results in a shallow, U-shaped average cost-of-capital curve. That is to say, the market value of the firm will rise to a point with an increase in the debt ratio. Beyond that point, any increase in the debt ratio will cause the market value of the firm to decline.
(Ariff and Lau, p. 391-410)
Precisely, the traditional view states that capital structure may impact the cost of capital and in that way influence the value of a firm. It holds that the reasonable or rational use of leverage will decrease the total cost of capital primarily and therefore also add to value. When leverage turns out to be excessively high, beyond an optimal point, the cost of capital will begin to increase and hence the value will decline. There is no specific recognition of how to measure either a moderate or reasonable or optimal capital structure (Ariff and Hassan, p. 11). Some have accepted a moving average of historical capital structure. others have accepted an industry ratio. This concept is depicted through Figure 1 below:
Although the traditional view appears to be substantially correct in relation to recognized real world behavior of capital structure, it suffers from lack of rigorous proof.
