Optimal Capital Structure

Debt and equity are considered to be an optimal capital structure. Its definition is commonly the techniques that firms should effectively utilize the available sources of finance to inject their capital to operate their business. There is a relation between this concept with the shareholders’ return after all; and thus one of could be considered and chosen as ‘more optimum’ as it will lower the overall cost of capital. In other words, we should have best capital structure by having right amount of equity and debt to cover the return required by the company.

As you can notice in my 3^rd blog, I had indicated that debt will be a much cheaper cost of finance that company could use rather than capital, which can make them happily reduce barrier to find a very high rate of return investments. But still, considering the risk of debt experienced by many businesses, including the one that had happened to Beazer Homes USA, Inc., is really necessary. 

The main issue today is that can you as a financial manager employ through your capital structure, on which way you weighted your cost of capital and which that will increase the project performance spread the capital by the and increase shareholder value. How can we alter our way to make the optimal capital structure in consequence?

In particular certain companies will have its own best fits because of the type of business that they are doing, but almost certainly more leverage can meant for more return. If looking at Sainsbury Plc., their strategy until recent time is by using the debt. The proofs are that the growth number of debt is higher in comparison to its equity according to its 11.89% rise in long term borrowings, while there is only 3.78% in its RE and reserves by the end of 2012. It is then the lower issue, transaction and monitoring and Sainsbury can use the tax advantages from it also, yet they should be able to control the cost financial distress risk which at this point cost of capital is started to increase again.

Additionally, Sainsbury need to be careful because shareholder value can be cut afterwards if the ‘down’ moment came, high debt will lead the company decide not to pay dividend to their shareholders and so on. The management of Sainsbury should take further concern that debt may also increase the WACC in terms of shareholder return as they need to be compensated. Undoubtedly, Sainsbury in this case could add only up to a certain point by assessing a traditional theory.