222

$show=home

Welcome to Accounting Education

The Accounting University with 3400+ Accounting contents as study material which can watch, read and learn anyone, anywhere.

Start your studies

$show=home

Journal Entries $type=three$count=6$author=hide$comment=hide$label=hide$date=hide$show=home$s=0

Balance Sheet $type=three$count=6$author=hide$comment=hide$label=hide$date=hide$show=home$s=0

How to Determine Optimal Capital Structure

For determining optimal capital structure, we should learn the importance of optimal capital structure first. Optimal capital structure is that point where our cost of capital and risk of business will be minimum.

So, for determining optimal capital structure, we have to follow following step :

1st Step : Find Different Capital Structure  with Debt Equity Ratio

Capital structure is the mixture of capital and debt. For example, we can take $100,000 capital and $ 0 debt or we can take $ 95000 capital through shares and $ 5000 debt through issue of debenture. Like this, there may be millions of capital structure by changing the value of share capital and debt value. Total capitalization value will be same. For easy understanding the capital structure, we will calculate debt equity ratio. Debt/equity will be debt equity ratio. For example $100,000 capital and $ 0 debt will be 0/100 debt equity. $ 95000 capital through shares and $ 5000 debt  will be 5/95 as debt equity ratio. Like this, we can calculate debt equity ratio 10/90, 15/85, 20/80, 25/75, 30/70, 35/65, 40/60, 45/55, 50/50, 55/45, 60/40, 65/35, 70/30, 75/25, 80/20, 85/15 and 90/10

At 90/10, we will at highest risk because we have just $ 10 capital for repaying loan of $ 90 and at 10/90, we are at lowest risk because we have $ 90 capital for repaying $ 10 loan. But we need to take optimum risk which we reach by taking next steps.

2nd Step : Find the Cost of Capital and Cost of Debt at Different Level of Capital Structure

Cost of capital is dividend rate and cost of debt is interest on loan rate. If there is lowest risk, both cost of capital and cost of debt will low. For example if debt equity ratio is 5/95, it means we have $ 95 capital for repaying $ 5 loan, this lowest risky capital structure, so, cost of capital will be 10% and cost of debt will be 4%. But when the risk of repayment of loan will increase due to increasing debt resource and decreasing capital resource, both cost of capital and cost of debt will increase. If debt equity ratio will be 90/10, its is one of highest risky capital structure in which we have just $ 10 capital for repaying $ 90 loan, so both capital and debt will become default because it is the basic rule when company will become insolvent, we use all the capital for repaying secured loan. So, $ 10 capital will become zero. and Rest $ 80 loan become zero. So, cost of capital will increase upto 16% and cost of debt will increase upto 8%. So, we have to calculate all the cost of capital and cost of debt on different capital structure.

3rd Step : Find the Weighted Average Cost of Capital

If we take the average of cost of debt and cost of capital, it will become average cost of capital. But weighted average cost of capital will give more suitable result. So, we will calculate WACC which is also average cost of capital but we take the product of cost of capital and debt equity ratio. For example, debt equity ratio is 10/90, and cost of capital 10% and cost of debt is 4%, then WACC will be

(0.10 X 4%) + ( 0.90 X 10%) = 9.4%

Like this, you can calculate all the average cost of capital at different level of debt equity ratio and cost of debt and cost of capital level.

4th Step : Reach Optimal Level of Capital Structure  Through Graph 


After showing, cost of capital, cost of debt and weighted average cost of capital and debt equity ratio on the graph paper, we can reach optimal level of capital structure. It is the point of debt equity ratio where is the weighted average  cost of capital will be minimum. Following is the graph paper which is taken from Murray State University's website. In simple words, if weighted average cost of capital is 8% and we can make our capital structure by getting loan between $ 75000 to $ 70,000 and keeping our capital between $ 30000 to $ 25,000.  This will become optimal capital structure.



Related : Meaning of Capital Structure

Comments

 


Name

access,2,account,86,accountant,95,Accounting,683,accounting definitions,99,accounting ebook,3,Accounting education,85,Accounting Education Ads Help,1,accounting procedure,2,accounting process outsourcing,2,Accounting Software,52,advance,3,advertising,6,africa,7,Amalgamation,6,amendments,16,Amortization,1,announcements,62,Annuity,2,assets,53,audit,47,auditing,41,Australia,2,B.Com.,22,balance sheet,87,bank,111,Bank reconciliation,12,banking,33,basic accounting,110,BBA,1,benefits,13,best,50,bill,12,black money,3,blog,12,bloggers,7,book keeping,4,bookkeeping,3,Branch Accounting - full tutorial,8,budget,35,Budget variance,13,business,65,businessman,9,CA,30,calculator,4,canada,3,capital,72,capital budgeting,27,career,21,cash,40,cash book,8,cash flow statement,11,Chiense,1,children,13,china,6,class,3,coaching,2,coins,2,college,6,commerce,10,commerce students,7,company,36,computer,9,computer accounting,1,conference,4,Contact vinod kumar,1,Control Your Spending,27,corporate accounting,69,cost,160,cost accounting,195,cost center,8,cost centre,1,CPA,2,credit,18,credit card,11,cs,10,currency,35,data,11,Debit and credit,17,debit cards,1,debt,62,debtor,21,degree,6,depletion,2,depreciation,38,Diwali Messages,12,documents,4,dollar,5,domain,3,Downloads,3,Dubai,1,e-accounting,17,earning,17,education,246,Education Loans,6,email,15,employee,4,EPF,2,ERP,7,euromoney,1,examination,7,excel,17,excise duty,6,expenses,65,facebook,7,factor of loan,1,fans,2,feature,32,fifo,5,FII,4,fiji,1,finacle,1,finance,823,Finance Journal Entries,6,Financial,134,financial accounting,147,Financial Statements,4,fire insurance,3,flickr,2,flow,4,forensic,4,forex,21,formula,8,france,1,fraud,6,free,2,fun,34,function,1,fund,48,GAAP,36,GDP,1,gdr,5,germany,1,gold,7,goodwill,4,goodwill accounting,3,google,34,google apps,3,google apps,1,google base,1,google buzz,1,google calendar,1,Google docs,38,google finance,3,google fusion tables,1,google talk,5,govt.,5,GST,33,guide,85,health,6,Hindi,2,Hindi Language,3,history,3,holding company,3,How to treat FBT in Tally 9,1,HRA,3,ICAI,11,ICAWI,3,ICICI Bank,1,IFRS,11,income,17,income statement,19,Income Tax,7,India,57,indian railway,1,Indonesia,1,inflation,4,inflation accounting,3,infographics,8,information,7,inspiration,176,insurance,14,insurance accounting,2,Intangible,3,interest,26,international,7,Internet,40,Introduction of Tally 9,1,inventory,41,investment,135,investment in Shares,6,invoice,3,IT,1,Japan,1,Job costing,4,journal entries,143,Journal Entries eBook Help,4,Kalculate,1,keyboard,3,kuwait,2,laptop,2,law,4,LBT,1,learning,36,lease,5,lecture,11,ledger,17,leducation,1,Leverage Analysis,7,liabilities,16,lifo,3,linkedin,1,loan,74,logical point,1,loss,5,loss of profit,1,M.Com.,5,m.phil,2,malaysia,3,management accounting,129,manual accounting,4,manufacturing account,1,market,11,marketing,3,mastercard,2,material,13,MBA,14,MCA,1,media,4,migration,2,mobile,9,money,61,ms word,3,ms. excel,14,multi currency in tally 9,1,Multicurrency Accounting,3,mutual fund,30,national security,1,new and sacrifice ratio,1,new york times,1,new zealand,1,news,1,NGO,5,nonprofit-accounting,6,North Georgia Mountains,1,Notification,1,NPV,17,NSE,1,odbc,2,office,10,oman,1,online application,2,online accounting,11,Online Accounting Course,5,otcei,1,pakistan,3,parents,3,Partnership,1,pay pal,3,pdf,4,Personal Finance,6,pie chart,1,pie chart of income,2,pnb,5,podcast,1,ppf,1,presentation,10,price,7,privacy policy,2,prof. vinod kumar,13,profit,24,profit and loss account,12,project management,11,provision,14,purchase,9,puzzles,2,quickbooks,2,Quote,22,quotes,42,quotes of svtuition,1,rating agency,2,ratio analysis,34,RBI,7,readers,13,real estate,13,rectification of errors,11,remote control,2,reports,10,reserves,8,responsibility accounting,4,retirement,2,revenue,3,Revenue reserves,2,review,7,risk,11,rupees,9,salary,5,sale,12,SAP,3,saudi arabia,1,saving,19,sbi,9,scholarship,2,school,1,SEBI,13,security,30,service tax,23,share,20,share trading,15,Shares,16,shri lanka,3,singapore,2,sms,6,social accounting,7,society,5,solution,219,South Africa,1,stock,24,stock exchange,22,structure,6,student,39,students,70,study,21,subsidiary company,2,svtuition,14,swiss bank,2,tally,100,tally 9,8,Tally 7.2,8,Tally 9,42,Tally.ERP 9,59,TallyPrime,1,tanzania,2,tax,94,Tax Accounting,30,TDS,15,teacher,62,teaching,112,technology,33,test,40,testimonial,15,testimonials,15,thailand,1,tips,60,trading,5,trading on equity,2,transaction,7,trend,12,trial balance,14,truthfulness,1,tuition,3,twitter,10,UAE,5,UGC - NET Commerce,13,UK,11,United Arab Emirates,1,university,9,usa,25,valuation,9,VAT,22,Video,36,Voucher and vouching,4,Wealth,8,wikipedia,25,working capital,29,youtube,14,
ltr
item
Accounting Education: How to Determine Optimal Capital Structure
How to Determine Optimal Capital Structure
https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOrTypoLn0psGEXUg5VQppLub1X92t8eXSa6vC8ohAP1i8XEDHHoLq5qOV-AQf7Ut3xUvJEHxcVm537jQG8H6pYSvD5x-cTTmCznRjoWHX8gycZmEyslrvsENUWJbhEnvfkklJ4HycsyIM/s640/optimal+capital+structure.PNG
https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOrTypoLn0psGEXUg5VQppLub1X92t8eXSa6vC8ohAP1i8XEDHHoLq5qOV-AQf7Ut3xUvJEHxcVm537jQG8H6pYSvD5x-cTTmCznRjoWHX8gycZmEyslrvsENUWJbhEnvfkklJ4HycsyIM/s72-c/optimal+capital+structure.PNG
Accounting Education
https://www.svtuition.org/2013/06/how-to-determine-optimal-capital.html
https://www.svtuition.org/
https://www.svtuition.org/
https://www.svtuition.org/2013/06/how-to-determine-optimal-capital.html
true
2410664366776677676
UTF-8
Loaded All Posts Not found any posts VIEW ALL Reply Cancel reply Delete By Home PAGES Contents View All RELATED CONTENTS FOR YOUR LEARNING Topic ARCHIVE SEARCH ALL POSTS Not found any post match with your request Back Home Sunday Monday Tuesday Wednesday Thursday Friday Saturday Sun Mon Tue Wed Thu Fri Sat January February March April May June July August September October November December Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec just now 1 minute ago $$1$$ minutes ago 1 hour ago $$1$$ hours ago Yesterday $$1$$ days ago $$1$$ weeks ago more than 5 weeks ago Followers Follow THIS PREMIUM CONTENT IS LOCKED STEP 1: Share to a social network STEP 2: Click the link on your social network Copy All Code Select All Code All codes were copied to your clipboard Can not copy the codes / texts, please press [CTRL]+[C] (or CMD+C with Mac) to copy