Factors in capital structuring - Free Essay Example

Sample details Pages: 6 Words: 1836 Downloads: 9 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? 1. Introduction The structuring of corporate finance is an issue of vital importance for all companies engaged in business. These companies require capital to start and run their businesses and while they are primarily guided in their decisions by financial and profit objectives, they also remain constrained by the uncertain risks which arise from remaining in the marketplace. Companies are financed by three avenues, equity funds provided by shareholders, internal profit generation and debt funds provided by outside lenders. Funding by way of equity and debt consists of different alternatives, for example equity funding could come from the promoters, or from sale of authorised stock to the public, to individual large investors like Venture Capital companies, Mutual Funds or to other high net worth investors. Similarly debt can be raised in many ways, e.g. through loans, debentures, bonds and other debt instruments from various lending sources. In the case of fu nding through internal accruals, very obviously this avenue is not available at the commencement of business. For profitable companies it is dependent, apart from the quantum of accruals, upon their dividend payout and earning retention policies. Debt, being in the nature of outside funds that necessarily need repayment, carries with it, elements of risk of default, bankruptcy and asset seizure. These have to be accordingly weighed while deciding upon its quantum. On the other hand debt funds also have the attraction of availability, low interest costs and tax deductibility with consequent positive effects upon company profitability. Equity funds, while being limited in some cases are theoretically safe, do not have to be repaid and do not entail a compulsory interest load. In actual fact shareholders expect much higher returns than lenders. They can also destabilise ownership patterns and effect changes in ownership and management. Furthermore, they need to be paid out of tax de ducted residual profits, thus imposing a charge on corporate profits, which is much higher than the cost of servicing debt. This dilemma is further compounded by practical considerations like access to equity and debt fund as well as objectives of the shareholders, the corporate managements who are the agents of the shareholders, and the debt holders. As such, despite progress in theories of corporate finance during the last twenty odd years, our understanding of the issue remains largely incomplete and continues to be shaped by newer thought on various issues including the effect of various levels of gearing on corporate efficiency, information asymmetry and costs of agency. It is the objective of this essay to study the various theories of corporate finance that govern capital structuring, the interplay of corporate management objectives and the effect of various other factors that determine decision making in the area. 2. Commentary Four major theories, the Modigliani-Mi ller model, the trade-off theory, the pecking order approach and the effects of symmetric information and agency costs comprise current thought on capital structuring. These theories are not mutually exclusive. Most companies are influenced by interplay of different facets of these theories resulting in a hybridised financing structure wherein different theories overlap and influence the final decision. The Modigliani-Miller approach is widely accepted as the theoretical base for the development of theories in capital structure. Developed in 1961 by Modigliani and Miller, it states that in a situation free of taxes, bankruptcy costs and asymmetric information, and in an environment of efficient markets, the value of a firm is independent of its mode of financing. It states that the market value of a firm is determined by its earning power and the risk of its underlying assets, and as such, is independent of the route chosen to finance investments or distribute dividends. The argu ment is uncomplicated. The theorem states that if the total cash flows a company earns are the same regardless of its capital structure, changing of structure will not affect cash flows. The total value of assets that provide ownership to these cash flows will also not change. While it is obvious that the assumptions of the MM theory regarding taxes, bankruptcy costs and asymmetric information are not possible in actuality, the theory becomes all the more relevant by inferring that disturbance of assumptions will necessarily lead to situations where capital structuring will depend upon debt and equity components in financing companies. In the years that have passed since the emergence of MM theory, while research into the reasons behind capital structuring decisions have led to a great amount of literature, much of the questions still remain. According to the trade off theory, the decision to limit debt to a certain level of total capital employed is a simple function of the firm to trade off the risks of profiting from higher debt and the consequences of default and bankruptcy. Capital structuring, as per this theory is thus ruled by trade offs between the tax shield provided by debt and the financial distress costs of bankruptcy. This will vary from firm to firm because while costs of financial distress will vary with the type of the asset, the benefit of the tax shield will change with the extent of profitability. At the optimal debt level the marginal benefit of the tax shield will equal the marginal cost of financial distress. The trade off theory does appear to provide some answers to the rationale behind capital structuring; its logic explains the differences in capital structure across industries with different profitability parameters and asset profiles. The trade-off theory, while logical, falls short of explaining the apparent unpredictability behind corporate financial structuring. It is unable, for example, to describe why profitable firms c onstantly underutilise debt. Some analysts have thought of this apparent shying away from debt, owing to fears of bankruptcy, to unnecessary conservatism that could cause harm to the company. The consensus view underlying this vast literature is that bankruptcy costs alone are too small to offset the value of tax shields and. thus, other factors, such as agency costs, must be introduced into the cost-benefit analysis to explain observed capital structures. Miller ((1977). p. 264) memorably characterizes the discrepancy by comparing the trade-off between tax gains and bankruptcy costs as like the recipe for the fabled horse-and rabbit stewà ¢Ã¢â€š ¬Ã¢â‚¬ one horse and one rabbit. (Ju, Parrino, Poteshman and Weisbach, 2005) A significant number of firms follow a financing structure that is inconsistent with the trade off theory, and use significantly lower levels of debt than their target debt level. Under leveraging results in underutilization of tax shields and there does no t appear to be a valid answer to the reasons à ¢Ã¢â€š ¬Ã…“whether observed capital structures represent a value maximizing choice or whether firms throw away value by substantially under leveraging their assets.à ¢Ã¢â€š ¬Ã‚  (Perrino, Poteshman and Weisbach, 2005) The use of the Pecking Order theory, the impact of asymmetric information and that of agency costs possibly provide the answers to these apparent incongruities. The Pecking Order theory stipulates that asymmetry in information availability exists between internal management represented by CEOs and external shareholders, i.e. corporate managements generally hold significant information unavailable to external shareholders and are thus often able to take decisions affecting the choice of internal and external funds that are seemingly at odds with corporate objectives. In the Pecking Order, profitable companies first look for internal funds, obtained from retained earnings, to finance investments. Companies are rel uctant to go to the market to look for borrowings even though their managements have full confidence in debt servicing ability, because of apprehensions of giving out wrong signals to the market and the possible undermining of their own position. This obviously has an effect on dividend policy and the tailoring of dividend payout to meet investment is common practice. In case of requirement of further funds, managements, who for all practical purposes are the agents of the stockholders, resort to debt instruments that send the least adverse signals to the stock market. The third and final choice for finance finally falls on the issue of further stock. In many cases, managements try to increase financial slack by increasing retained earnings, avoiding available debt, and smoothing dividend payouts. Financial slack is valuable and Debt Equity ratios respond mainly to changes in imbalances between funds retained after dividend payouts and investment opportunities. The use of interest t ax shields and raising debt to maximize value thus becomes secondary. The Pecking Order theory implies that retained funds stay at the top of the preferred financing heap and external equity remains the last choice. The choice of debt comes up not in order to increase value but because of exhaustion of internal funds. 3. Conclusion Capital structuring depends upon a number of factors and is not as complex an issue as it appears to be. Modes of capital structuring primarily depend upon availability of capital. Start up corporations as well companies with weak profitability or irregular cash flows are often constrained by unavailability of external equity as well as of debt. These companies have to perforce manage with internal accruals and loans from the unorganized sector until their financial credibility becomes strong enough to attract external equity and debt. In the case of profitable companies that are able to access debt, maximization of firm value vis-ÃÆ'  -vis ca pital structuring requires the incorporation of debt until the achievement of a target debt figure, which in turn represents the optimum balance between the financial benefit of the interest tax shield and the cost of financial distress, because of bankruptcy. While this logic applies to capital structuring decisions in many companies, decision making in a number of firms also works on the Pecking Order theory, enabled by asymmetric information availability and the occurrence of agency costs. Managements of such companies, which are distinct from stockholders, tend to use their position to use funds from retained earnings for investment decisions due to their own considerations. Their desire not to create ripples in the outside market leads them to treat debt as a second choice. The benefits of the tax shield are not inducement enough to overrule their desire to create financial slack and keep buffers that would enable them to operate with some element of comfort. While this atti tude is possibly inevitable to a certain extent, it becomes a matter of concern when it acts as a precursor to other decisions and becomes an indicator of the managementà ¢Ã¢â€š ¬Ã¢â€ž ¢s decision to place their own interests before that of the stockholders. Bibliography Brown, C. M. 2005, Borrowing from Dad: Financing from Relatives and Friends Has Risks and Rewards. Black Enterprise, 35, 44. Chew, D. H. (Ed.). 1986,. Six Roundtable Discussions of Corporate Finance with Joel Stern. New York: Quorum Books. Ju, N, Parrino, R, Poteshman, A, Weisbach, M, 2005, Horses and rabbits? Trade-off theory and optimal capital structure, Journal of Financial and Quantitative Analysis, Vol. 40, No.2, University of Washington Mansi, S. A., Reeb, D. M.,2002, Corporate International Activity and Debt Financing. Journal of International Business Studies, 33(1), 129+. Read, L. 1998, The Financing of Small Business: A Comparative Study of Male and Female Business Owners. London: Rout ledge. Roe, M. J. ,1994, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance. Princeton, NJ: Princeton University Press. Don’t waste time! Our writers will create an original "Factors in capital structuring" essay for you Create order

Comparing the American and French Revolutions - 1488 Words

Abstract In this paper, we look into the history of both United States and French right before times of revolution. It therefore, compares and contrasts the French and America revolution and looked into the similarities of some f the events just right before the revolution took place. In conclusion, we look at the perception of the people on the methods used by both countries to push for revolution. Introduction Similarities Both French and America had various similarities and differences in histories of events which resulted to their revolution. The America revolution of 1775-1783 and French revolution of 1789-1799 were driven with a desire to draft a new constitution that restore the respect of human rights and abolish unfair taxation (Tatsiana Amosava, 2011). However, it resulted to the demonstration in Boston in 1760, led by Rev. Jonathan Mayhew shouting No taxation without representation and taxation without representation is tyranny. The British parliament used to control everything, trade and tax both imports and exports. Americans felt that they were being denied their historic rights, which was the Bill of Rights of 1760, and therefore started to forbid tax without consent of parliament (Nicole Smith, 2009). This, however led to the rejection of the Stamp Act of 1765 which was brought in by British Prime Minister George Grenville and violently rejected the remaining tax on tea imports under Tea Act which was passed in May 1773, at Boston TeaShow MoreRelatedEssay on Comparing The French Revolution and The American Revolution1339 Words   |  6 PagesA revolution, by definition, is the overthrow of one government followed by replacement with another. The American Revolution against the British during 1775 to 1783 and the French Revolution pitting the French people against their own government during 1789 to 1799 were both very important political and social turnovers. 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What is Cryptography Free Essays

Technology has developed throughout the years, which has been shown by changes in different aspects of how people live their daily lives. One example could be the means of transportation which started from horses during early times to carriages, invention of automobiles, aircrafts, submarines and many more which we use at present. Through centuries, sending of messages has also evolved from messenger mail to electronic mail via the World Wide Web. We will write a custom essay sample on What is Cryptography? or any similar topic only for you Order Now Along with these are rising security threats to senders and receivers of those messages who fear that their mail would be opened by someone else. It is and has been the same problem ever since. How can these security threats and privacy invasions be avoided then? The main topic of this research is the importance of a science that helps everyone. It could be in terms of technology to the benefit of computer enthusiasts and industrialists, or simply for protection of the privacy of each citizen. The following pages would give the readers a brief introduction of the subject at hand, Cryptography. Along with its definition, history, forms and uses, readers would also be able to learn how important this science is and why each person should use it in their daily communication. According to the Merriam-Webster online dictionary, Cryptography is the enciphering and deciphering of messages in secret code or cipher, the computerized encoding and decoding of information. It is also known as secret writing. Derived from the Greek words kryptos, which means hidden and the grafo, meaning write, is the transformation of data into a secure message, so that unintended recepients would not be able to understand or use them. (Wikibooks, Inc. , 2007). Cryptography is used to hide information by means of encryption, therefore making data unreadable to those who don’t have the secret key that can decipher or decrypt the message into an understandable one. Encryption is done when information is transformed into something which others might see as useless. This is called ciphertext. The act of transforming the said information into an understandable format with the use of a cipher or secret key is called decryption. (Wikibooks, 2007) The use of cryptography is seen today through its many uses. These include the security of ATM cards, electronic commerce and computer passwords. These are used for access control and confidentiality of secure information. (Cryptography, 2007) Such techniques like microdots and combining words with images are used by cryptographers to hide information from unintended recepients. (Pawliw, 2006) The earliest known use of cryptography is Classical Cryptography. It shows that it has been thousands of years since cryptography was first done. History has stated that the first proof of the use of cryptography dates back to 2000 BC. It has been related with the Egyptians’ practice of hieroglyphics which consisted of complicated pictograms seen carved into monuments of Ancient Egypt. These pictograms were hard to interpret and only a chosen few knew what their real meanings were. Some time within 500 and 600 BC, Hebrew scholars made use of simple substitution ciphers like the Atbash Cipher in order to solve these encrypted messages. According to Wikibooks, the first known use of a modern cipher was by Julius Caesar (100 BC to 44 BC): â€Å"†¦who did not trust his messengers when communicating with his governors and officers. For this reason, he created a system in which each character in his messages was replaced by a character three positions ahead of it in the Roman alphabet. † (Wikibooks, 2007) By the time of World War II, there has become a great use of mechanical and electromechanical cryptographic cipher machines, but the usage of these was very impractical. During this time, there were various developments in both mathematical and practical cryptography. When the period of modern cryptography began, Claude Shannon, father of mathematical cryptography, published the paper Communication Theory of Secrecy Systems in the Bell System Technical Journal in 1949. Shortly after that, along with Warren Weaver, he published the book Mathematical Theory of Communication as well. Because of those publications, a solid theoretical basis for cryptography and for cryptanalysis was established, which made cryptography known only by secret government communications organizations such as the NSA. It was only in 1969 that the public again saw developments in the field of cryptography: â€Å"First was the DES (Data Encryption Standard) submitted by IBM†¦ in an effort to develop secure electronic communication facilities for businesses such as banks and other large financial organizations†¦ it was adopted and published as a FIPS Publication (Federal Information Processing Standard) in 1977†¦has been made effectively obsolete by the adoption in 2001 of the Advanced Encryption Standard†¦DES was the first publicly accessible cypher algorithm to be ‘blessed’ by a national crypto agency such as NSA. The release of its design details by NBS stimulated an explosion of public and academic interest in cryptography. † (Wikibooks, 2006) Here are the important terms related to Cryptography in detail; Encryption is the act of hiding information using cryptography. Processed information in this manner is said to be encrypted. Decryption is the process of translating encrypted information. The Key is like a password used to encrypt and decrypt information. A transmission channel used to transmit information in secrecy is called a Secure Line, while a Public Line is the opposite. An example of which are public pay phones and the Internet. (Wooledge , 2000) There are several types of Cryptography being used today. In order to further explain the types of Cryptography, Wooledge compared the Key to a key to a door. First among these is the Symmetric Cipher, which can sometimes be called a symmetric key. Most of the time, it is used for simple types of cryptography because a same key is used to encrypt and decrypt the secret message. â€Å"Everybody who should have access to the room is given a copy of the key†¦put new information in, take old information out†¦if you send somebody a copy of the key by way of the Post Office, somebody working at the Post Office could intercept this key†¦allow them to access this same locked room, and do the same things with it†¦letting them read everything you locked up with that key, even letting them modify it. â€Å"(Wooledge , 2000) The Public Key Cryptography is more complex because in this type of cryptography there are two keys used and together, they are called a key pair. The key used to encrypt is called the public key, which can be given to anyone in order to send information to the owner of the private key, which will be used to decrypt information sent to him. The most common example of this is the use of electronic mail over the internet, also known as email. The public key is an email address which one gives out to his friends. This allows them to send information to the holder of the secret key, the owner of the email address, the only one who has the password to open and translate the information sent to him or her. (Wooledge , 2000) A One Time Pad is used to send high security messages such as national secrets and is considered the only perfect encryption in the world. In this type of encryption, both the sender and receiver has a copy of the pad to be used as a symmetric key to hide and unhide a message sent over a secure line and destroys them after it has been used. A good example of this is the one seen in Mission Impossible movies, wherein Ethan Hunt receives messages that self-destruct. (Wooledge , 2000) For the sake of totality, it would be best to include Steganography, the science of hiding information from people who would spy on a person. This type of encryption is designed not to let spies know that there is indeed a something hidden in a certain message. It is very effective, but only used occasionally. (Wooledge , 2000) Along with the internet, there is a large growth in the variety of forms of electronic communications, making its security very important. There are a number of enumerated uses for Cryptography such as protection of e-mail messages, credit card information, corporate and other important information. (Jupiter Media Corporation, 2004) After a brief background on Cryptography, readers would come to know why it is important to use them in their daily activities. The following are common concerns, goals or objectives that answer the above stated question. Message Confidentiality; Encrypted messages would only be understood by intended recepients of a certain message. If a sender would want to hide certain information from the public or from someone in particular, it would be best that cryptography is used. In that manner, only the receiver would have the key to translate the message into a useful and understandable one. Message Integrity; If an encrypted message is intercepted and changed during the sending process, it would easily be known by the receiver, which secures its integrity. Sender Authentication; It would be possible to make sure of the identities of both sender and recepient of the message. With cryptography, the recipient would be able to verify the true identity of the sender, along with the origin and destination of the message. Sender Non-Repudiation; This would prevent a sender from denying an intention to send and that he or she is the true sender of the said message. (Wikibooks, 2007) Though these cryptographic procedures are effective enough to achieve the goals, and concerns mentioned, it is still important for receivers and specially senders to practice caution such as creating a password with a very strong integrity, logging off private systems when they are not being used by the owner and keeping all private information to oneself. (Pawliw, 2006) Works Cited Cryptography. (2006). In Merriam-Webster Online Dictionary [Web]. Merriam-Webster, Incorporated. Retrieved January 24, 2007, from http://www. m-w. com/cgi-bin/dictionary? book=Dictionaryva=cryptography Cryptography. (2007). In Wikipedia, the Free Encyclopedia [Web]. Wikimedia Foundation, Inc.. Retrieved January 24, 2007, from http://en. wikipedia. org/wiki/Cryptography Pawliw, B (2006, January 13). Cryptography. Retrieved January 24, 2007, from Search Security. com Web site: http://searchsecurity. techtarget. com/sDefinition/0,,sid14_gci214431,00. html Wikibooks, (2006, November 1). Cryptography/History of Cryptography. Retrieved January 24, 2007, from Wikibooks, the Open-Content Textbooks collection Web site: http://en. wikibooks. org/wiki/Cryptography/History_of_Cryptography Wikibooks, (2007, January 10). Cryptography/Introduction. Retrieved January 24, 2007, from Wikibooks, the Open-Content Textbooks Collection Web site: http://en. wikibooks. org/wiki/Cryptography/Introduction Wooledge , G (2000, October 11). What types of cryptography are there?. Retrieved January 24, 2007, from wooledge. org Web site: http://wooledge. org/~greg/crypto/node5. html How to cite What is Cryptography?, Papers