The capital structure and the real value of the company

The capital structure refers to how an entity finances its activities through a combination of equity and debt, providing an understanding of how an entity finances its activities through its own or third-party resources.

To find out more about the real value of a company, we invite you to continue reading the following article and get to know our Specialization in corporate financewhere we will teach you in depth everything about the capital structure.

What is capital structure theory?

The theory of the capital structure is related to the cost of capital of the company, in the studies that have been carried out on this subject there are many opinions that highly appreciate the optimal capital structure but fail to unify the criteria, some have argued that could achieve an optimum, however, others were convinced that this was not possible, reaching only a consensus that there should be a good match between the resources obtained from debt, equity, preferred stock and equity instruments. The property used by the business. They can finance their investments.

The way to determine the optimal capital structure is the one that maximizes the company's share price linked to the cost of capital, which therefore must be minimized.

Goal of the capital structure

The goal of the capital structure is to find a balance between the financial instruments used to obtain financing. Corporate financing is ultimately all the money a business has to fuel its operations.

Characteristics of the capital structure

There are four main characteristics to take into consideration regarding the capital structure:

1. Financial risk of the company's equity, when a company is dependent on debt financing, the required return on equity will increase, as debt financing increases the risks to shareholders.
2. Conservative or aggressive attitudes of the administration.
3. Financial flexibility or ability to raise capital.
4. Tax position of the company, interest is deductible, which reduces the effective cost of debts. If you have a low tax rate, debt will not be beneficial.

The capital structure is approaching

The optimal capital structure is essentially divided into those who support the theory and those who believe that this optimal does not exist, therefore the following approaches are presented:

• Traditional Approach: This approach is that a company can reduce its cost of capital and increase its total value through judicious use of leverage, which leads to the fact that the cost of capital is not independent of the company's capital structure and that there is a capital optimal structure.
• Approach to net income: It consists in the fact that the profits available to ordinary shareholders are capitalized at a constant rate calculated by dividing the net operating profit of the company by the total value of the company.
• Approach to EBIT: the assumption for this approach is that there is an overall capitalization rate of the company for any degree of leverage. The market capitalizes the value of the company on a global basis and therefore the breakdown between debt and equity does not matter.
• Modigliani and Miller approach: This approach claims that the relationship between leverage and cost of capital is explained by the net operating income approach; They argue that the total risk for all of the company's equity holders is unaffected by changes in the capital structure and therefore is the same regardless of the funding mix.

How to calculate the real value of the company?

Companies are made up of assets, liabilities and equity, with equity financing the assets. However, to value the company it is necessary to know what assets and collection rights it has, and to discount what is owed from this value.

The capital structure must be known, since the debt to be deducted is external debt only. Therefore, this value will be the difference between assets and liabilities, which corresponds to your net worth. Therefore, the true value of the company is what you have minus what you owe.