A combination of different sources of funding for an entity, whereby it will finance its assets and operations (and growth). Capital structure consists of debt and/ or equity components, depending on the type of the company (equity-financed or deb-financed or equity-debt financed).
More specifically, capital structure is made up of equity capital and/ or debt capital. Equity capital arises from ownership shares in a company, representing claims to its future cash flows and profits and of course in its net assets (residual interest). Debt capital is a type of capital that is financed by borrowed funds (debt). It is a form of financing that allows an entity to raise funds by borrowing money from the public (e.g., creditors or investors). As a borrower or seeker of external sources of funds, an entity must repay the borrowed amount (the debt) along with interest over a specific period. Debt capital is a source of short- to long-term financing that a business taps into in order to finance its operations (usually for growth purposes). Certain hybrid forms of capital (preferreds or preferred stock) can also be part of a capital structure.
For companies, the decision as to the optimal capital structure involves management’s endeavor to determine the financial leverage that maximizes the value of the company (or minimizes the weighted average cost of capital, WACC). Difference scenarios and considerations for the optimal mix of debt-equity or irrelevance of capital structure are tackled under the so-called Modigliani and Miller theory that analyzes the effect of taxes, for example, on the value of a company, among other factors.
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