Capital Structure Avenues that can Impact the Value

How capital structure affects worth is depended on the debt effect on the weighted average cost of capital and or free cash flow. A series of steps must be followed to the capital structure understudy to get the weighted average cost of money. First, evaluate the lowered beta and cost of equity. The second step is to estimate the interest rate and cost of debt, find the weighted average cost of capital, and finally calculate the value of operations. The value of operations is the present value of free cash flows discounted by the new weighted average cost of capital. This process aims at finding the amount of debt financing that will maximize the value of the operation. Capital structure is also known for maximizing shareholder wealth and the intrinsic price of inventory.

As the ratio of debt rises, both equity and debt costs increase. The first increases at a slower rate, then, at some point, it starts to accelerate. Eventually, the increasing cost of debt and equity offset the fact that more debt is being used (Kumar et al., 2017). The debt remains to be less costly than equity. Although the cost of the equity component is often more extensive than that of debt, financing with almost nothing but the debt would not maximize value. Equity financing dilutes the ownership of a company, which ultimately hurts investors over time. It explains why the weighted average cost of capital decreases as the debt increases.

For this reason, the weighted average cost of capital affects the value. However, the debt financing sole cost is the interest paid, and it does not push risk to investors. So, it is normal for a weighted average cost of capital to decrease as the debt increase because firms or companies are solely responsible for the weight of their financing. When a firm or company records a decrease in weighted average cost of capital, the level of debt may rise or remain constant. It is very typical for an organization because its financial department can easily detect that and adjust accordingly.

Only the stock cost is considered in the weighted average cost of capital, while debt after tax is not. To compute a weighted average cost of capital, the total cost of equity and debt are added together, then multiplied by earnings after applying the tax rate. It is why capital has a lower weighted average cost of capital than equity (Rauh & Sufi 2010). Because the cost of debt after taxes is lower than the cost of equity, the weighted average price of...

…operating income by rising revenue. It arises when a firm must experience fixed costs when producing products and services. When a company undergoes a fixed price during production, the percentage change in profits, when the volume of sales increases, is higher than the percentage change in sales. Operating leverage mainly earns high returns when sales growth occurs, but it gains losses during bad times. It leads the company to business risk.

Operating break-even point(Qbe) = fixed cost/ (sales price- variable cost)

Variable cost = v- Q (expected units sold)

Fixed cost=200, variable cost = 10, sales price = 15

Qbe = F/ (P - V)

Qbe = 200/ (15 10)

Qbe = 200/ 5

Qbe = 40

Operating break-even point = 40

The recommendation for a financial decision to the pizza palace is to ensure there is financial leverage. It is because financial leverage will maximize the value of the pizza palace and their associate. Additionally, the weighted average cost of capital will be maximized. According to Miller and Modigliani, a theory developed with no taxes, the capital structure will remain irrelevant, and it does not affect the company's value. Key concepts related to business risk include financial risk, which shows how a company spends its financial leverage and takes care of its debt loan. Operational risk concerns its self with the ability of the…