Corporate Finance

Topics: Finance, Weighted average cost of capital, Corporate finance Pages: 4 (1436 words) Published: March 25, 2013
There is nothing like optimum capital structure for a firm. The Optimal Capital structure is that Capital Structure at which the weighted Average cost of capital (Ko) is Minimum. It is that combination of Equity and Debt at which the total cost of capital is mini-mum.

Trade-off theory argues that there's an optimal amount of debt of each firm. At this level of debt, firms can take the most advantage of debts. Debts can be tax shield so that they can save money for firms to reinvest in other projects so as to earn more profits. However, debts can be quite dangerous because highly leveraged firms may face bankruptcy and financial distress costs (no matter they're direct or indirect) may increase the cost of debt of the company. Therefore, there must be a level of debt that make the benefits of debt and potential danger of debt offset each other. In another word, the marginal revenue of debt equals the marginal cost of debt. But remember, the real cases are not as easy as we put here.

When a firm procures funds from investors or owners, there will be an explicit or implicit promise to pay return to them. The return is paid in terms of interest which is compulsory paid to all investors and owners, but the return paid to owners in the form of dividends is optional. The dividend decision by any firm, like the investment and financing decisions is also taken for maximization of market price of the share. The term dividend refers to that the portion of profit (after tax) which is distributed among own-ers/shareholders of the firm and the profit which is not distributed is called as retained earnings Dividend Payout Ratio is determined by the dividend policy adopted by the company, and it is im-plemented to decide about the percentage of profits to be distributed by the firm to its own-ers/shareholders. Dividend is always depends on the total profit that a firm acquired after taxes. There are a few factors that affect the Dividend policy of a company. They...
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