Capital Structure and

Long-Term Financial
Decision
 Capital Structure
• Can be a mixture of company’s long-term debt,
short-term debt, common stock, and preferred
stock
• When analysts refer to capital structure, they are
most likely referring to a firm's debt-to-equity (D/E)
ratio, which provides insight into how risky a
company's borrowing practices are. Usually, A
company that is heavily financed by debt has a
more aggressive capital structure and therefore
poses greater risk to investors. This risk, however,
may be the primary source of the firm's growth.
 Debt
• Allows to retain ownership unlike
equity
• Less expensive than equity
• Interest payments
• Tax advantage
 Equity
• allows outside investors to take
partial ownership in the company
• more expensive than debt, especially
when interest rates are low.
• does not need to be paid back in
case of declining earnings
 Measures of Capital Structure
Companies that use more debt than equity to
finance their assets and fund operating activities
have a high leverage ratio and an aggressive
capital structure. A company that pays for assets
with more equity than debt has a low leverage
ratio and a conservative capital structure. That
said, a high leverage ratio and an aggressive
capital structure can also lead to higher growth
rates, whereas a conservative capital structure
can lead to lower growth rates.
 Dividend Growth Model or Gordon Growth
Model
Given a dividend per share that is payable in
one year and the assumption the dividend
grows at a constant rate in perpetuity, the
model solves for the present value of the
infinite series of future dividends. Because
the model assumes a constant growth rate,
it is generally only used for companies with
stable growth rates in dividends per share.
Dividend Growth Model
 Gordon Growth Model (GGM)
It was named in the 1960s after American
economist Myron J. Gordon.
The Gordon Growth Model (GGM) is used
to determine the intrinsic value of a stock
based on a future series of dividends that
grow at a constant rate. It is a popular
and straightforward variant of a 
dividend discount mode (DDM).
 Dividend Discount Model
The dividend discount model (DDM) is a quantitative
method used for predicting the price of a company's
stock based on the theory that its present-day price is
worth the sum of all of its future dividend payments
when discounted back to their present value. It
attempts to calculate the fair value of a stock
irrespective of the prevailing market conditions and
takes into consideration the dividend payout factors and
the market expected returns. If the value obtained from
the DDM is higher than the current trading price of
shares, then the stock is undervalued and qualifies for a
buy, and vice versa.
 Capital Asset Pricing Model
The Capital Asset Pricing Model (CAPM) is a
model that describes the relationship between
the expected return and risk of investing in a
security. It shows that the expected return on
a security is equal to the risk-free return plus
a risk premium, which is based on the beta of
that security. Below is an illustration of the
CAPM concept.
Capital Asset Pricing Model
 CAPM formula
The CAPM formula is used for calculating the
expected returns of an asset.  It is based on the
idea of systematic risk (otherwise known as
non-diversifiable risk) that investors need to be
compensated for in the form of a risk premium
. A risk premium is a rate of return greater
than the risk-free rate. When investing,
investors desire a higher risk premium when
taking on more risky investments.
• Capital structure is how a company funds its overall
operations and growth.
• Debt consists of borrowed money that is due back
to the lender, commonly with interest expense.
• Equity consists of ownership rights in the company,
without the need to pay back any investment.
• The Debt-to-Equity (D/E) ratio is useful in
determining the riskiness of a company's
borrowing practices.