Capital structure and profitability thesis

  • Stability of sales- An established business which has a growing market and high sales turnover, the company is in position to meet fixed commitments. Interest on debentures has to be paid regardless of profit. Therefore, when sales are high, thereby the profits are high and company is in better position to meet such fixed commitments like interest on debentures and dividends on preference shares. If company is having unstable sales, then the company is not in position to meet fixed obligations. So, equity capital proves to be safe in such cases.

    Companies can raise capital with either debt or equity . Each strategy has its own advantages and disadvantages. Debt usually costs less than equity due to tax advantages, especially when rates are low. However, debt also obligates the company to pay out a portion of future earnings, even when earnings are declining. By contrast, equity does not need to be paid back; however, equity comes with an exchange of ownership. Most companies use a mix of both debt and equity to raise capital. This mix is referred to as the capital structure. It is the goal of most public companies to operate at an optimal capital structure to maximize profits.

    Capital structure and profitability thesis

    capital structure and profitability thesis

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