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Capital Structure Decision

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Capital Structure Decisions The article "Debt is good for you" examines the theories relating to equity and debt financing as the developments in the corporate bond markets. While the article "Debtor's prison: Companies made a fashionable mistake" talks about the relation between the credit ratings of non financial companies with so-called "efficient" balance sheet approach. "Debt is good for you" talks about the different approaches a firm can take when it comes to debt to equity ratio. While the most commonly taught and most commonly talked about theory is the Modigliane-Miller theory which suggested that a firm's overall value should increase as it substitutes debt for equity, the one's preferred by managers are the variations of the trade-off theory which says that the amount of debt a firm is willing to take on depends, among other things, on the business it is in Profitable companies with stable cash flows and safe, tangible assets can afford more debt; unprofitable, risky ones with intangible assets, rather less. ...read more.


As suggested by Corporate-finance theory the value of a company should not be affected by its decision to finance itself with equity or debt. But, in practice, interest payments are generally tax-deductible; dividends are not. These reasons cause a firm to hold less cash on hand and have higher debt to equity ratios. But in recessions this kind of theories backfire causing a rise in default rate which in turn makes it difficult to roll out new debt, in all this the investors downgrade the firm. Reading the articles a financial manger is better having a lower debt to equity ratio than a higher one. The manager depending on the firm's business should have enough cash on hand as well as keep the dividends distributed in check. Per me the manger should use the conservative "trade off" approach as that one takes seems to take the expected future cash flows into account more than the Modigliane-Miller theory. ...read more.


It argues that excessive faith in mathematical models of finance led to unsustainable growth in securitized derivatives. The article looks at the use and abuses of mathematical models. It also asks us the question if risk has gotten ahead of the world�s ability to manage it and whether it can be tamed again. It tries to imply that the banks do not understand the complexity of the securities they were trading in. The article suggests that the government regulators are not up to date to regulate the latest securities created using these complex mathematical models. This suggests that unless a financial manager understands the complexity of the security, which a majority of them don't, they should not use those securities in their capital structure, as the consequences of working with something a person don't understand is not in their hands. As a Financial manager of a company you are suppose to maximize the shareholders profit, hence using the complex securities which the manager cannot understand is taking too much of a risk with shareholders money. ?? ?? ?? ?? ...read more.

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