Capital Structure Theories Introduction - Accounts and Finance for Managers

The capital structure theories are facilitating the business fleeces to identify the optimum capital structure. The optimum capital structure of the organization differs from one approach to another due the assumption which are underlying with reference to many factors of influence. The success of the firm is normally depending upon the rate at which the financial resources are raised, differs from one organisation to another depends upon the needs. The cost of capital is having greater influence on the EBIT level of the firm; which directs affects the amount of earnings available to the investors, that finally reflects on the value of the firm. The more earnings available at the end will lead to greater return on investment holdings of the investors, would enhance the value of shares due to greater demand. There are two set of approaches with reference to capital structure; which normally influences the Value of the firm through the cost of overall capital(Ko) is one approach called relevance approach capital structure theories and other do not have any influence on the value of the firm is known as irrelevance approach.
The debt finance in the capital structure facilitates the firm to enhance the value of EPS on one side on the another side it is subject to the financial leverage with reference to trading on equity. The application of leverage in the capital structure enhances the value of the firm through the cost of capital.

The following are the various capital structure theories:

  1. Net income approach
  2. Net operating income approach
  3. Modigliani and Miller approach
  4. Traditional approach

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