Giving the following 2 capital structures available to fund a project: Capital Structure A Capital Structure...
Giving the following 2 capital structures available to fund a project:
|
Capital Structure A |
Capital Structure B |
||||||
|
Sources of fund |
Weight |
Source of fund |
Weight |
||||
|
Common shares |
25% |
Preferred shares |
25% |
||||
|
Bonds |
20% |
Loan |
35% |
||||
|
Retained earnings |
45% |
Bond |
35% |
||||
|
Loan |
10% |
Common shares |
5% |
||||
If both capital structures have WACC of 12.5%, which capital structure you recommend giving that the finance manager is risk seeker (taker)? Why?
Homework Answers
Finance manager of A is a risk seeker. On thr basis of risk seeking , we should choose capital structure of A because a high proportion of investment is done in stocks i.e. 70% , and stocks are considered to be more riskier than bond due to it's volatility. Retained earnings is also a part of equity and has similar risk as equity, reason why I have said 70% stock.
Where as in capital structure of B 70% of the investment is in fixed securities which are more or less stable, and only 30% in stocks.
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Giving the following 2 capital structures available to fund a
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