Features of an Appropriate Capital Structure

Features of an Appropriate Capital Structure

Return: The goal of firm should be to have optimal debt in the capital structure, leading to the highest return to the shareholders i.e. to increase return on equity (ROE) with the equivalent level of return on assets (ROA).
The company needs funds to finance its activities continuously. Every time when funds have to be procured, the financial manager weighs the pros and cons of various sources of finance and selects the most advantageous sources.

Risk: Financial manager aim at determining that level of debt in capital structure, where risk-return trade-off is optimal.

Flexibility: In generally, most of the firms do not exhaust their debt capacity in order to maintain flexibility.

Capacity: If most of the firm’s assets are intangible in nature, the debt capacity will be low, as firm has little to offer as collateral for the loan. In case of non-performing assets, lenders feel uncomfortable in negotiating the deal with the firm.

Control: From control perspective, the use of debt in capital structure is preferred. This holds the true as the issue of equity results in dilution of control.

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