Theories of capital structure

Question

Write down the theories of capital structure?

Answer 1

Capital structure is a word that is referred to be the mix of sources from that the long term funds are needed for business intentions that are raised to improve the capital of the company. The theories that are involved in these are illustrated below:-

1) Net operating income (or NOI) :- this is an approach in that both value of the firm and weighted average cost are free of capital structure. Individual holding the debt and equity obtains the same cash flows without worrying about the taxes as they are not involved in it.

2) Traditional approach and Net income (NI) approach : - this is an approach in that both equity and cost of debt are independent of capital structure. The constituents that are involved in it are stable and do not depend on how much debt the firm is employing.

3) MM hypothesis with and devoid of corporate tax : - This approach tells that firm's value is independent of capital structure. The same return can be obtained by shareholders with the similar risk.

4) Miller’s hypothesis with personal and corporate taxes : - This approach provides significant advantage over equity. This ignores agency costs and bankruptcy.

5) Trade-off theory : - settlement and costs of leverage.