CAPITAL STRUCTURE THEORIES

Capital structure Theories describe the relationship between capital structure, cost of capital and the value of the firm.

CAPITAL STRUCTURE

Capital structure is the mix of long-term sources and it includes equity capital, preference shares and long-term debt capital. The capital structure must be decided in a way that it protects the owner’s interest by assuming an optimal return continuously.

Assumptions of Capital Structure Theories

  1. There are only two sources of finance i.e. debt and equity.
  2. There are no taxes.
  3. Entire earnings are distributed as dividends; the dividend payout ratio is 100%.
  4. There are no retained earnings.
  5. The company has an infinite life.
  6. The operating profit (EBIT) is given and is not expected to grow.
  7. Total assets of the company are given and are not expected to change.
  8. Business risk is constant over time and is independent of capital structure and financial risk.