Question

There is a tradeoff between capital structure and flexibility; Comment.

Answer 1

Capital structure refers to the amount of debt and/or equity employed by a firm to fund its operation and finance its assets.A firm capital structure is typically expressed as a debt to equity or debt to capital ratio.The tradeoff theory of capital structure is the idea a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits.There is advantage of financing with debt,the tax benefit of debt and there is a cost of financing with debt,the cost of financial distress including bankruptcy cost of debt and non bankruptcy costs.The marginal benefit of further increases in debt declines as debt increases,while the margianl cost increases,so that a firm that is optimizing its overall value will focus on this trade off when choosing how much debt and equity to use for financing.