CAPITAL STRUCTURE FEAUTURES

Question No. 2. (b) Explain the features of an appropriate capital structure.

Solution: The optimal capital structure of a firm should have the following features:

1. Return

The objective of firm should be to have optimal debt in the capital structure, which yields maximum return to the shareholders i.e. to increase return on equity (ROE) with the same level of return on assets (ROA).

ROE = ROA + (D/E) [ROA – I (1-Tc)] Where: D = Proportion of debt in the capital structure E = Proportion of equity in capital structure I = Interest rate (current yield to maturity) on debt Tc = Corporate income tax rate

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