Capital structure

Today's lecture focuses on capital structure, a cornerstone of corporate finance. Capital structure is the mix of financing methods a firm uses to fund operations and investments, mainly debt, equity, and sometimes hybrid instruments like mezzanine finance. The right combination significantly affects a company's risk, profitability, and resilience to economic shocks. The balance between debt and equity shapes the cost of capital, returns to shareholders, and the firm's long term survival, influencing both stability and growth prospects. Let's break down the main components. Debt in the form of loans or bonds, allows a firm to borrow capital with the obligation to pay interest and eventually principle. Equity, by contrast, represents ownership, a claim on future profits, but with greater risk, as shareholders are last to be paid in liquidation. The United Kingdom, share capital aligns with equity. While in the United States, it is called common stock. Debt is often less costly due to tax deductibility and lower risk to lenders. Hybrid instruments like mezzanine finance, sit between debt and equity, providing flexibility, but usually at a higher cost. The blend of these sources is crucial for managing cost and financial flexibility. Two influential theories guide capital structure decisions, the trade off theory and the pecking order theory. The trade off theory suggests firms weigh the tax benefits of debt against