13.2 The Firm’s Capital Structure

  1. LG3

  2. LG4

Capital structure is one of the most complex areas of financial decision making because of its interrelationship with other financial decision variables. Poor capital structure decisions can reduce the value of the firm by increasing the cost of capital, thereby lowering the NPVs of investment projects and making more of them unacceptable. Effective capital structure decisions can increase the value of the firm by lowering the cost of capital, resulting in higher NPVs and more acceptable investment opportunities.

Types of Capital

All the items on the right-hand side of the firm’s balance sheet, excluding current liabilities, are sources of capital. The following simplified balance sheet illustrates ...

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