Capital Structure
Explanation: Capital structure refers to the way a corporation finances its operations and growth by using different sources of funds. This includes a mix of debt (long-term and short-term), equity (common and preferred stock), and sometimes other financial instruments. The capital structure reflects the firm’s overall financial strategy and its approach to balancing risk and return.
Example: A company might have $500 million in equity and $300 million in debt, giving it a capital structure of 62.5% equity and 37.5% debt. This mix can influence the company’s risk profile and cost of capital.
Reference Link: For more information on capital structure, visit Investopedia’s Capital Structure.
FAQs:
- Why is capital structure important?
- It affects the company’s risk, cost of capital, and ability to secure financing and achieve growth.
- What is the difference between debt and equity financing?
- Debt financing involves borrowing money that must be repaid with interest, while equity financing involves selling ownership stakes in the company.
- How does capital structure impact a company’s financial health?
- A well-balanced capital structure can reduce risk and optimize the cost of financing, while a poorly balanced structure can increase financial vulnerability.
- What is the optimal capital structure?
- The optimal capital structure balances the cost and risk of debt with the cost and dilution of equity, maximizing shareholder value.
- How do changes in interest rates affect capital structure?
- Rising interest rates increase the cost of debt, potentially leading companies to rely more on equity financing and vice versa.