The Traditional Approach To Capital Structure

1201 words - 5 pages

The traditional approach to capital structure
The traditional approach stresses the benefits of using the combination of cheaper debt and equity finance to find the optimal capital structure, so the total value of firms will be increased with the sensible debt. (Watson and Head, 2013) Of cause, the model was created which based on a certain assumption 1) There is no tax at a personal or a corporate level. 2) The perpetual debt finance and ordinary equity shares are the financial choices for firms. 3) The capital structure can be changed without incurring issue or redemption costs. 4) Any debt finance is up or down, which will lead to the same situation in equity finance. 5) All distributable earnings will be regarded as dividends by companies. 6) The relative business risks of companies keep existing over time. 7) The earnings and dividends of a company will not be increased over time.
To understand this traditional approach in depth, the theory model is illustrate in figure 1.

(Watson and Head, 2013)
As the figure showed, the cost of equity curve (k_e) is presenting a rising trend with the increasing gearing because of the growing level of financial risks of shareholders. The steeper rate of curve (k_e) at the higher level of gearing which embodies that the investment value of shareholders is being threatened by the risk of company bankruptcy. It can be seen that the cost of debt (K_d) is not increasing until at level of gearing. Hence the bankruptcy risks also threat to the debt holders. The point A stands for the company began to use the cheaper debt finance instead of the expensive equity, it will lead to the lower weight average cost of capital (WACC) initially. When the WACC curve reduced to point B, it got the optimal capital structure at point X where the company value is maximized and the WACC is minimized. However, WACC will eventually be forced gear up. As the same as the cost of equity and debt, it also has a faster rate at the high gearing.

Miller And Modigliani Theory
(I).The Net Income Approach
Miller and Modigliani’s net operating income approach emphasizes the value of company is irrelevant to the capital structure which depends on the actual assets of firms rather than the market value of debt and equity.Based on the assumptions outlined in the traditional approach, this model added an extra assumption that the bankruptcy risk of capital market could be ignored. The figure2. is used to explain this capital structure approach in detail.

(Watson and Head, 2013)
The linear relationship between the cost of equity curve (k_e) and the level of gearing illustrated that the cost of equity will grow up along with increasing financial risks faced by shareholders. The cost of debt curve (K_d) become a straight line parallel to the level of gearing, the reason is that the cost of debt will not face bankruptcy risks and not...

Find Another Essay On The Traditional Approach to Capital Structure

Compare and Contrast the structure of "Waiting for Godot" with the structure of any traditional play.

962 words - 4 pages Traditional drama, like in "Oedipus the King" by Sophocles, reflects a world view composed of a rational, well-ordered universe, a comforting system of beliefs (faith in something, someone), a stable scale of values, an ethical system in working condition. (Johnson, 2006). Beckett, in "Waiting for Godot", has turned away from the traditional drama and has an entirely different world view. This world view is marked by chaos instead of order....

The new managerial thoughts and organisational approaches like empowerment, delegation decentralisation and self-managed teams has ensued the changes as compared to the traditional approach.

1683 words - 7 pages 1. Introduction The role of a manager is rapidly changing and demands a fresh perspective at present situation. The new managerial thoughts and organisational approaches like empowerment, delegation decentralisation and self-managed teams has ensued the changes as compared to the traditional approach. 2. Classical approach of the manager Traditional or classical management focuses on efficiency and includes...

Approach to enhancing the workplace

1479 words - 6 pages PAGE PAGE 1 Running Head: ENHANCING THE WORKPLACE Approach to Enhancing the WorkplaceGillian DavalosQueens CollegeAbstractPsychology offers access for enhancing productivity in the workplace. Wiegand and Geller (2003) make reference to a number of factors we should focus on to enhance individuals' success while providing a positive and supportive workplace climate. The discussion...

Critically assess the Pecking Order Theory of Capital Structure

1785 words - 7 pages There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than...

This paper compares and contrasts the Appreciative Inquiry approach with traditional human resource management strategies

1597 words - 6 pages The human resources (HR) profession has changed dramatically in the past century. Gone are the days when HR's primary functions were hiring, policing, and bookkeeping. In today's dynamic workplace, human resource professionals are expected to add value to their organizations. Traditionally, human resource's approach to problem-solving was to isolate a problem, uncover...

The Formalistic Approach to Hay's Rapunzel

844 words - 3 pages The Formalistic Approach to Hay's Rapunzel   Prayer has been always a symbol of faith, and even in modern poetry it is still used as a desperate cry to the One in Heaven. One of the great examples of this desperate cry would be Sara Henderson Hay's "Rapunzel".After reading her modern version, familiarity with Grimm's fairy tale "Rapunzel" will reveal a completely new interpretation. Sara Hay chooses Rapunzel's prayer to be in the...

Psychoanalitic Approach to The Minister’s Black Veil

2504 words - 10 pages    "All within hearing immediately turned about, and beheld the semblance of Mr. Hooper, pacing slowly his meditative way towards the meeting-house. With one accord they started, expressing more wonder than if some strange minister were coming to dust the cushions of Mr. Hooper’s pulpit·" Working in the realm of the Gothic, Nathaniel Hawthorne hits upon psychological points that few of his readers are willing to explore. Of course, one may not...

An Attempt to Identify the Personality Approach

875 words - 4 pages An Attempt to Identify the Personality Approach In an attempt to identify the personality approach of an incest victim in a recent magazine article, I have estimated that the approach is behavioral/social. Numerous occurrences of childhood incest made Deborah Mays (Bergner, 2000, p. 119) experience a cycle of depression well into her late thirties. Because she was a helpless child subjected to ongoing accounts of physical and mental abuse by...

The Life-Span Developmental Approach to Counseling

982 words - 4 pages The life-span development approach addresses the basic nature versus nurture debate by allowing for both. Just as our physicals selves are determined by both genetics and lifestyle, so are our emotional selves. As a Licensed Professional Counselor, I plan to consider life-span development to specialize in counseling a specific type of person with hopes of becoming well-versed, and therefore more helpful, in the types of experiences that group...

The Human Response to Physical Structure

1549 words - 6 pages The Human Response to Physical Structure Most of the world's inhabitants view space and structure through visual elements such as bricks, rock, vegetation and foliage, hallways, doors, windows, trims, and flooring. These elements combine to allow each individual's experience of a space. The German word gestalt means form or shape. Gestalt psychology attempts to investigate the human mind and how it conceives of or recognizes patterns. Scientists...

The Decline of Traditional Family Being Detrimental to Society

805 words - 3 pages The Decline of Traditional Family Being Detrimental to Society Some people believe that the decline of the traditional family (Nuclear family) is detrimental to society because a lot of people are not socialising. This is one of the basic roles that a traditional family performs for individuals to meet the expectations of society. Only through a family can a person play a full part in society. In addition, society...

Similar Essays

Individualized Approach To Instructions Versus Traditional Approach To Teaching.

1841 words - 7 pages Question: Compare and contrast individualized approach to instruction and traditional Approach to teaching.Some researches state that individualized instruction originated between 1910 and 1920. This system was unpopular and failed perhaps because...

“Access To Capital Structure, And The Funding Of The Firm”

1446 words - 6 pages Introduction In this essay, I will give brief review notes for “Access to Capital Structure, and the Funding of the Firm” (Omer Brav 2009) which will be focused on the goal of this easy, how and why the theoretical hypotheses are tested and what are the findings. Some discussions about data, methodology used and theory defects will also be included in this essay for critical comment. Content Objective Since earlier capital structure...

Research Paper: The Research On Using A Tethered Agonist Approach To Map The Structure Of The Receptor

857 words - 3 pages The tethered agonist approach to mapping ion channel proteins – toward a structural model for the agonist binding site of the nicotinic acetylcholine receptor. Research by Lintong Li, Wenge Zhong, Niki Zacharias, Caroline Gibbs, Henry A Lester, Dennis A. Dougherty. Condensation of the Research Purpose of the Study: The purpose of the study was to develop a structural model for the nicotinic acetylcholine receptor and use newer techniques...

Structure, Conduct, And Performance Approach Of The Public Transportation Industry

1707 words - 7 pages In this paper, I will analyze the structure, conduct, and performance approach of the Public Transportation Industry in general and then concentrate on the local (regional) aspect and talk about SEPTA. Before I go in-depth, I will briefly tell you what I am planning to achieve in my discussion. For structure, I...