Factors That Influence the Capital Structure Decision of the Firm

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ABSTRACT

The capital structure decisions are influenced by various factors. Different researchers obtained different conclusions on what the important determinants of capital structure are. The main objective of this study is to ascertain the factors that significantly influence capital structure decisions. The factors tested are: The firm’s age, size, growth, tangibility, profitability, business risk and non-debt tax shield. From my analysis all these factors were found to be significant but at varying levels, with profitability and company growth as the most significant.

TABLE OF CONTENTS
Declarationii
Acknowledgementiii
Abstractiv
Table of Contents v

CHAPTER 1.
1.0 INTRODUCTION……………………………….....….…………………..……………1 1.1 BACKGROUND…………………………………………….……..….....................1 1.2 STATEMENT OF THE PROBLEM………………………………………...……..2 1.3 OBJECTIVE OF THE STUDY ……...……………………...………………….. …3 1.4 IMPORTANCE OF THE STUDY …...………..……………………………….......4

CHAPTER 2
2.0 LITERATURE REVIEW ……………………………………….…….…….. ……5 2.1 INTRODUCTION ……………………………………………….….…………….5 2.2 THE CHOICE BETWEEN DEBT AND EQUITY ……………..………………..6 2.3 CAPITAL STRUCTURE THEORIES …………………………….………..…….6 2.3.1 THE VALUE OF THE FIRM GIVEN CORPORATE TAXES ONLY.......…..6 2.3.2 THE VALUE OF THE FIRM IN A WORLD WITH BOTH CORPORATE AND PERSONALTAXES…………………….…………………..….…11 2.3.3 INTRODUCING RISK: A SYNTHESIS OF CAPM AND MM........ ………13 2.3.4 THE COST OF CAPITAL WITH RISKY DEBT …………………………....1 6 2.3 5 THE MATURITY STRUCTURE OF DEBT………,,…….…17

2.4 OPTIMAL CAPITAL STRUCTURE…………………………..………..18 2.4.1 POSSIBLE REASON FOR AN OPTIMAL MIX OF DEBT AND
EQUITY ………………………………………………………….19

CHAPTER 3
3.0 RESEARCH METHODOLOGY AND DESIGN ………………………..………23 3.1 POPULATION ……………………………………………………………..………23 3.2 SAMPLE ……………………………………………………………………………23 3.3 DATA COLLECTION METHOD ……………………………………….………23 3.5 DATA ANALYSIS METHOD ………………………….………………….……..24

CHAPTER 4
4.0 DATA ANALYSIS AND INTERPRETATION…………...…………………….26 4.1 INTRODUCTION……………………………………...…………………………26 4.2 ANALYSIS OF FINDINGS…………………………………………………..…..27 4.1.1 TANGIBLITY………………………………………………….……….27 4.2.2NON-DEBT TAX SHIELD………………………………….…………27 4.2.3BUSINESS RISK (EARNING VOLATILITY)……………….…..….27 4.2.4A FIRM’S SIZE…………………………………………………….…..27 4.2.5GROWTH……………………………………………………………….28 4.2.6PROFITABILITY……………………………………………..……….28

CHAPTER 5
5.0 SUMMARY AND CONCLUSION………………………………………….......29 5.1 LIMITATION OF THE STUDY………………………………………………...29 5.2 RECOMMENDATIONS…………………………………………………………30 5.3 RECOMMENDATION FOR FURTHER RESEARCH……………………….31 APPENDIX 1……………………………………………………………………………32 APPENDIX 2……………………………………………………………………………33 APPENDIX 3……………………………………………………………………………35 LIST OF TABLES……………………………………………………………………...39 LIST OF FIGURES…………………………………………………………………….39 REFERENCES…………………………………………………………………………40

CHAPTER ONE
1.0INTRODUCTION
1.1BACKGROUND
The term capital structure has been defined in different ways by different authors. Weston and Copeland (1988) defines capital structure as the firm’s mix of debt and equity financing that affects the cost of capital that is it explains how the cost of capital is related to shareholder’s wealth and shows how to extend the cost of capital concept to the situation where projects do not all have the same risk. Brealey and Myers (1984), for example define capital structure as the firm’s mix of different securities. Emery Gray W. explains capital structure decision as choice between debt and equity. The decision affects the common stockholders’ expected rate of return, how their rate of return changes or varies in response to changes in economic conditions and risk of financial distress as well.

The decision of whether to finance an enterprise with Long-term debt or Equity sources is what the capital structure decision comprises of. Studies highlighted have found that the decision is based on certain factors, Omondi...
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