CAPITAL STRUCTURE AND THE THEORY OF PERFECT CAPITAL MARKETS
Does paradise exist in the world of finance?
The central question of this chapter (and of the following one) is: is there an optimal capital structure? That is to say, is there a “right” combination of equity and debt that allows us to reduce the weighted average cost of capital and therefore to maximise the value of capital employed (enterprise value)?
THE VALUE OF CAPITAL EMPLOYED
While accounting looks at a company by examining its past and focusing on its costs, finance is mainly a projection of the company into the future. Finance reflects not only risk but also – and above all – the value that results from the perception of risk and future returns.
In finance, everything is about the future – return, risk and value.
From now on, we will speak constantly of value. As we saw previously, by value we mean the present value of future cash flows discounted at the rate of return required by investors:
- equity (E) will be replaced by the value of equity (VE);
- net debt (D) will be replaced by the value of net debt (VD);
- capital employed (CE) will be replaced by enterprise value (EV), or firm value.
We will speak in terms of a financial assessment of the company (rather than the accounting assessment provided by the balance sheet). Our financial assessment will include only the market values of assets and liabilities:
|ENTERPRISE VALUE or FIRM VALUE (EV)||VALUE OF NET DEBT (VD)|
|EQUITY VALUE (|