Project Planning and Control

Meaning and Features of Optimum Capital Structure

An optimum capital structure can be defined as a financing mix incurring the least cost but yielding maximum returns. It is obtained when the market value per equity share is the maximum.

According to Ezra Solomon, Optimum capital structure can be defined as that mix of debt and equity which will maximise the market value of a company i.e. the aggregate value of the claims and ownership interests represented on the credit side of the Balance sheet. Further, the advantage of having an optimum capital structure, if such an optimum exist, is two fold. It minimises the company’s cost of capital which in turn its ability to increase and find new wealth by creating investment opportunities. Also by increasing the firm’s opportunity to engage in future wealth creating investment, it increases the economy’s rate of investment and growth.

Features of Optimum Capital Structure

  1. An optimum capital structure involves minimum cost and the maximum returns.
  2. It should be flexible enough to fulfill the future requirements of the capital as and when  needed.
  3. It has that much usage of debt capital which is within the repaying capacity of the enterprise.
  4. It ensures a proper control over the affairs of the enterprise. In any case, it should not be a control diluting one.

Theoretical and empirical research suggests that financial planner should plan optimum capital structure. In practice, however, financial management literature does not provide specified methodology for designing a firm’s optimum capital structure. Financial theory has not developed to a point where you feed the relative information and data into the computer and an optimum capital structure comes out. As a result, human judgement must be used to find a balance between the various factors influencing a capital structure.

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Sarvesh Arora

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