Assignment 1, Assigment 2

Assignment 1

Capital Structure the composition of company’s debt and equity, the balance between debt and equity that business uses to finance its assets, day to day operations, and future growth. When equity is used without debt the firm is set to be unlevered. Otherwise, the firm is levered, and the amount of debt determines the firm's degree of leverage. As per Modiglian and Miller (M&M) theory of capital structure, Proposition I: firms’ value is independent of the firm's capital structure, Proposition II: a firm's cost of equity capital is a positive linear function of the firm's capital structure. 

Business risk is the single most important determination of capital structure, and it is riskiness inherent in the firm's operation if uses no debt. The more debt a company has the more cash company needs to pay each period to creditors so the riskier company becomes. There are loads of factors which may impact business risk such as demand variability, competition, input cost variability and operating leverage. Financial leverage is extent to which securities of fixed income are used in firm's capital structure.

According to Modigliani and Miller (M&M) theory without taxes, the cost of equity decreases with the decrease in debt proportion in the capital structure. The decrease in debt proportion leads to decrease in risk faced by equity shareholders and therefore seek less compensation for their risk. According to (M&M) the capital structure does not affect the weighted average cost of capital (WAAC). The increase/decrease in the cost of equity will be such as to offset decrease/increase in the cost of debt keeping WACC constant.