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    FM Portfolio Activity #5.edited

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    imbukahmesh
    UNIT 5

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    FM Portfolio Activity #5.edited

    Uploaded by

    imbukahmesh
    9 views3 pages
    UNIT 5

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    FM Portfolio Activity #5.Edited

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    UNIT 5

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    9 views3 pages

    FM Portfolio Activity #5.edited

    Uploaded by

    imbukahmesh
    UNIT 5

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 3

    1

    Briefly Explain Why Company Valuation is Influenced by Capital Structure Decisions

    Capital structure refers to the amount of debt and /or equity employed by a firm, to fund its

    operations and finance its assets (Tim, 2024). It merely refers to the long-term sources of capital

    of the firm. The capital structure of a company is one of the key decision-making points along

    with investment decisions and distribution decisions. A company's capital structure is important

    because it affects how its financial affairs, activities as well as investments. It also determines the

    ratio of debt to equity that a business uses to finance its operations. As a result, the capital

    structure of a firm affects its financial health and market value. Companies seek to maintain an

    optimal capital structure whereby the balance of debt and equity capital maximizes the market

    value of the company while minimizing the cost of capital (Trugman, 2016).

    A balanced or optimal capital structure positively impacts the value of a company since it allows

    the company to minimize financial risk while at the same time benefiting from the interest tax

    shield benefit. Ordinarily, the cost of debt is lower than the cost of equity thus the utilization of a

    fair proportion of debt in the capital structure reduces the weighted average cost of capital (Abor,

    2005). Furthermore, a well-balanced structure provides financial flexibility, which positively

    influences valuation by reflecting the company's ability to pursue growth opportunities.

    However, the utilization of more debt in the capital structure of a firm lowers its value. Where

    the debt-to-equity ratio is too high, equity holders will demand a higher return on capital to

    compensate for the high financial risk.

    Potential investors look at the capital structure and identify the amount of debt raised by the

    company and this helps them to assess the risk of financial distress. A high risk of financial

    distress is associated with bankruptcy. Yet, having too little debt on the books can prevent the
    2

    company from keeping up with the industry growth rates. In conclusion, the capital structure of a

    firm has a direct impact on its value.

    Progress Report

    This week marks another huge milestone towards the completion of this module. I have

    understood the various business valuation approaches; market-based, assets-based, and income

    approached, among others. I find this knowledge relevant to my profession since it will help me

    to understand company valuation. After this week, I am confident that I can value any company

    using a relevant business valuation approach. Furthermore, I understand the pros and cons of

    each business valuation model thanks to my research and the informative discussion forum. I

    look forward to the next topic. My sincere gratitude to our able instructor for their continued

    support and guidance.


    3

    References

    Abor, J. (2005). The effect of capital structure on profitability: an empirical analysis of listed

    firms in Ghana. The Journal of Risk Finance, 6(5), 438-445.

    Tim, V. (2024, July 23). Capital Structure. Retrieved from Corporate Finance Institute:

    https://corporatefinanceinstitute.com/resources/accounting/capital-structure-overview/

    Trugman, G. R. (2016). Understanding business valuation: A practical guide to valuing small to

    medium-sized businesses. Hoboken: John Wiley & Sons.

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