The structure of capital is an important aspect in the determination of the financial health of a firm. It demonstrates with clarity the proportion of debt versus own capital in the total capital of a firm. If a firm uses fixed cost sources of finances then it is referred to as leveraging. In this case, the higher the ration of debt in total finances the higher the leveraging. Capital structure The structure of capital determines the ability of a firm to attract investors into the firm (Capobiano & Fernandes 2004, p. 424).
The combination of capital is what is called capital structure. A firm may use equity only, or debt only, or the combination of the two; equity and debt or even equity, debt and preference shares to finance its operations (Jain 2009, p. 34). The capital of a firm consists basically of equity (which consists of retained earnings and funds raised through sale of shares) and debt (mainly borrowed funds) (Madura 2006, p. 500). A capital structure affects the cost if capital, net profit, earning per share, dividend payout ratio and the liquidity of a firm (Dhankar & Ajit 1996, p.
29). Designing efficient capital structure The design of a prudent capital structure is an issue that boggles many a financial managers. This is because the structure of the capital of a firm determine is the lifeline on the firm. First, an efficient capital structure should minimize as much as possible the cost of capital (Tim et al. , 2005, p. 323). Relative low cost of capital ensures that a firm achieves set down goals as and when planned without struggling. Secondly, it reduces the risks that may crowd the operations of a firm.
In this case, the risk of high costs of operations related to cost of capital, bankruptcy risks or even the risk of inability to attract new investors due to a dented capital structure is eliminated (Beer & Friend 2006, p. 551). Moreover, a capital structure should be designed to give a firm the possible flexibility in altering its features without strain. Additionally, the capital structure should make it possible for owners to retain the control of the firm (Zhang 2005, p. 662).
Although debt financing is the easily available form of raising capital in the short run, the leverage should be designed in a manner that ensures that the control of the firm is within the owners (Shim & Joel 2000, p. 178). This is because there are more risks associated with relinquishing control to creditors. Another characteristic of a prudent capital structure is that it should enable the firm top have enough finances. Despite the above prudent measures, a capital structure should be designed in a manner that makes the firm raise enough finances to fund the operations and long term plans (Zhang 2005, p.
659). Theory of optimal capital structure It states that the firm can achieve optimum capital structure. In this case, the firm can raise the debt translating to raising the value of the firm to an extent. Thus the level of debt can be raised to some level which is the ideal capital structure (Capobiano & Fernandes 2004, p. 432). This makes the goal of any financial manager to be achieved of increasing the value of the firm which increases wealth. The cost of capital A firm’s cost of capital is a culmination of many factors.
For instance, the cost of retained earnings represents the opportunity cost of declaring dividends or retaining the funds for internal use in the firm (Shim & Joel 2000, 170). Additionally, there is an aspect of opportunity cost in issuing shares to raise finances. Here, the opportunity cost is the benefits shareholders would have obtained should that have not purchased the shares. The cost of debt for a firm is easier to measure than cost of retained earnings (Xiaodong et al. , 2008, p. 176).
This is because the firm incurs interest on borrowed funds. The costs of capital for large company say a Multinational Corporation (MNC) differ with that of a small domestic firm in the following manner. First, the size of the company is an issue. Given that a company may possess a strong financial basis and may be borrowing a substantial amount of funds, it could be given preferential terms by lenders. This means reductions in the cost of capital (Kurshev & Ilya 2005, p. 2). Secondly, large companies have access to international capital markets.
This makes them to have the option of choosing the lowest cost of capital than the domestic market can offer (Madura 2006, p. 502). For MNC, the use of foreign funds may have less exposure on the firm to foreign exchange risks given that high revenues from the subsidiaries in the same currency cushions them against the risk. Moreover, the exposure to country risks is another issue that affects big companies (Beer & Friend 2006 p. 557). Some countries may pass repressive policies that make it difficult for a firm to operate.
According to a study done on 26 medium Indian companies, the cost of capital decreases with increase in debt level because cost of debt is less than that of equity and there is tax exemption on interest payments (Dhankar and Ajit 1996 P. 33). In U. S large firms coincidentally have higher leverage that small ones. Part B: Motives of corporate restructuring and methods of executing mergers and acquisitions Corporate restructuring is the proactive step taken by firms to re-engineer their corporate existence. It is a process that involves redesigning one or more aspects of a firm.
The process of corporate restructuring may take the form of take-over, corporate acquisitions and bankruptcy. Corporate ought to actively make tactics and strategies that will enhance their survival in future (Heller 2006 P. 1). a) Improving efficiency and profitability The process of improving the profitability and efficiency of a firm may involve daring measures of corporate restructuring. For a firm to continue operating profitably, it ought to have consistent attributes of providing the best quality, excellent service and great innovation (Heller 2006).
A firm may have run short of resources to effect this, or even its corporate culture may be limited in this thus seek and alliance with another that possesses the same. The cash that is raised during a restructuring process is vital in investing in new systems and capital expenditures that could assist in improving efficiency (Figge & Hahn 2005, p. 55). b) Surviving market place dynamism There is nothing is business sense as bad as failing to acknowledge changes 3in technology and consumer preferences. Many firms have gone under for failing to strategize on how to cope a dynamic market (Lang 2002, p.
170). Corporate restructuring in form of alliances and acquisitions have been effected to assist ailing firms survive a rapid technological or any other operating environment dynamism. Present financial melt down has made many firms to consider corporate restructuring. In this case, departments have been merged, employees layoffs and facilities closed down to reduce the operating costs at the height of reduced sales. c) Facing competition This is common especially where one firm holds a significantly high market share in comparison to the others (Zhang 2005, p. 662).
For instance, in the internet web searching industry, Google has 54% market share leaving Microsoft Corp and Yahoo Inc to hold 10% and 22% respectively in market share (Albanesius, 2007). Microsoft and Yahoo have been in talks for long to merge their web searching to find a way of challenging the market dominance of Google Inc. A merger could be the better option to respond to sluggish economy, drop in sales thus reorganizing the finances to survive the times (Wisegeek, 2009). d) Increasing share prices at the stock market Mergers normally attract huge publicity. This is so especially when two giant companies come together.
The increased appetite for the shares by investors makes the company shares to increase in value thus reflecting company worth (Taverna 2002, p. 26). Investors normally commit their monies to this arrangement with the enthusiasm that in the long run they will reap good returns. e) Hybrid management after a corporate restructure A corporate restructuring exercise results to introduction of a flare of management from the two companies. The platform of sharing management experience and strategies is a core competitive advantage of beating rivals in the industry (Wash, 2008).
Forms of mergers and takeovers Corporate restructuring may take place especially when it becomes apparent the corporate has outgrown the original structure making it impossible to run the corporation. The following are some methods under which takeovers and mergers take. a) Commercial partnership Under this, an alliance is formed where one company outsource the services of another thus making the two to cooperate in challenging a rival that is deemed holding a larger market share (Wash, 2008). This type is common in service firms which have a serous implication of mergers.
Additionally, it can takes place in arrangements that are deemed to have future uncertainty (Figge & Hahn 2005, p. 52). For instance, the much hyped merger between Microsoft Corp and Yahoo Inc, Yahoo prefers a commercial partnership while Microsoft prefers an acquisition (Wash, 2008). In this case, Yahoo Inc is negotiating to outsource its web-search and related advertisement to Microsoft Corp. b) Takeover bid This is a process where a large firm moots a plan to buy another firm which is smaller in comparison. This form is a forced from of taking control of a firm.
The buying out involves determining the average price of shares and submitting the value of the shares in cash to the shareholders (Lehto 2006, p. 18). If it so happens, the larger firm obtains a controlling share of ownership of the small acquired firm. c) Formal merger This is a strategy where firms come together to join forces into a single entity. The move towards joining forces could be driven by the above explained strategies. Horizontal mergers take place when two or more companies doing same business come together to form a single unit (Business Blog, 2009).
On the other hand, vertical mergers take place when two companies that produce a good at a different stage of production take place. d) Joint Venture The process involves firms coming together to form a single unit that is essential in facing prevailing market conditions (Lehto 2006, p. 12). In this arrangement, the firms come together to form an entity that will provide a forum for sharing their strengths and capabilities and also business risks. e) Strategic alliance This arrangement doesn’t lead to formation of a new company.
Instead it redefines the cooperation between two firms. Each company remains independent after the formation of a strategic alliance (Business Blog, 2009). Strategic alliances are known to aid firm access useful resources like foreign technology, foreign markets and distribution channels. The also are good at benefiting from treasure of business intelligence knowledge especially for a new firm when it cooperates with an already established firm (Lang 2002, p. 178). Conclusions The structure of capital of a firm is a vital aspect of any business that plans to compete effectively.
Today, financial managers have graduated from the traditional roles previously tagged on them as fund raisers. Today they strategically design the best capital structure to propel the firm to the next level of performance. The significance of capital structure is that, capital structure affects the cost of capital, net profit, earning per share, dividend payout ratio and the liquidity of a firm. The optimal structure should thus be designed. On the other hand, corporate restructuring has gained adoption in the contemporary business world.
Firms are forming strategic alliances and mergers to increase efficiency and profitability, overcome competition and increase wealth to shareholders among other reasons. In this case, among the various forms of corporate restructuring include; mergers, joint ventures, commercial partnerships and takeovers among others. Finally, the management should critically look at the type of corporate restructuring on the value of shareholders before entering into such arrangement. References Albanesius, C. (2007), Would a Microsoft-Yahoo merger work? PC world, Accessed 24 June 2009 <http://www.
pcmag. com/article2/0,1895,2126193,00. asp> Beer P & Friend F 2006 ‘Environmental accounting: a management tool for enhancing corporate environmental and economic performance’, Ecological Economics, vol. 58, no. 3 pp. 548-560 Business Blog, 2009 Mergers, acquisitions, joint ventures and strategic alliances Accessed 24 June 2009 < http://www. businessblog360. com/2009/03/16/mergers-acquisitions-jvs-and-strategic-alliances/> Capobiano, H. M & Fernandes, E. 2004 ‘Capital structure in the world airline industry’, Transportation Research Part A: Policy & Practice, vol. 38, no. 6, pp.
421-435 Dhankar, R. S and Ajit, S. B 1996 ‘Cost of capital, optimal capital structure, and value of firm: an empirical study of Indian companies’ Vilkalpa, vol. 21, no. 3, pp. 29-35 Accessed 24 June 2009 <http://209. 85. 229. 132/search? q=cache:itPFMFtaEQcJ:www. vikalpa. com/pdf/articles/1996/1996_july_sep_29_36. pdf+cost+of+capital+and+capital+structure+in+financial+management&cd=30&hl=en&ct=clnk&gl=ke> Figge, F. & Hahn, T. 2005 ‘The cost of sustainability capital and the creation of sustainable value by companies’, Journal of Industrial Ecology, vol. 9, no. 4, pp. 49-58
Heller R 2006 Agile management Accessed 24 June 2009 < http://www. thinkingmanagers. com/management/agile. php> Jain T. K 2009 Capital structure decisions in financial management, Center for social entrepreneurship Accessed 24 June 2009 <http://www. scribd. com/doc/14647011/Capital-Structure-Decisions-in-Financial-Management-7-November> Kurshev, A. & Ilya, A. S 2005 Firm size and capital structure, Accessed 24 June 2009 <http://www. gsb. stanford. edu/FACSEMINARS/pdfs/KuSt-Paper-2005-11-01-3. pdf> Lang, D. W 2002 ‘A Lexicon of inter-institutional cooperation’, Higher Education, vol. 44, no.
1, pp. 153-183 Lehto, E. 2006 ‘Motives to restructure industries: Finnish evidence of cross border and domestic mergers and acquisitions’, Journal of Financial Management, vol. 85, no. 1, pp. 1-21 Loof, H. 2004 ‘Dynamic optimal capital structure and technical change’, Structural Change & Economic Dynamism, vol. 15, no. 4 pp. 449-468 Madura, J. 2006 International financial management, Mason, Ohio: Thomson / South-Western Shim, J. K & Joel, G. S. 2000 Financial management, Hauppauge, N. Y: Barron’s. Taverna, M. A. 2002 ‘European clock reset on mergers and takeovers’, Aviation Week ; Space