MANAGEMENT

Detailed explanation-1: -The traditional approach to capital structure advocates that there is a right combination of equity and debt in the capital structure, at which the market value of a firm is maximum.

Detailed explanation-2: -The traditional theory of capital structure states that when the weighted average cost of capital (WACC) is minimized, and the market value of assets is maximized, an optimal structure of capital exists. This is achieved by utilizing a mix of both equity and debt capital.

Detailed explanation-3: -The theory of the traditional structure of valuing a firm suggests that there is an optimal debttoequity ratio that has a minimum overall cost of capital and maximum market value of a firm. On the sides of this point, changes in the financing mix can bring positive changes to the value of a firm.

Detailed explanation-4: -The cost of equity is higher because there an uncertainty of dividend and repayment of capital. Therefore equities are always considered as higher risk source of fund.

Detailed explanation-5: -The capital structure theories use the following assumptions for simplicity: 1) The firm uses only two sources of funds: debt and equity. 2) The effects of taxes are ignored. 3) There is no change in investment decisions or in the firm’s total assets. 4) No income is retained.