Question

Capital structure is a major topic in corporate financial management. The way a company finances itself over time becomes apparent by looking at their balance sheet. In the Pacioli Company assets of $299,000 were balanced by $231,000 of liabilities (77.3%) and $68,000 of equity (22.7%). So over time, Pacioli tends to finance itself borrowing 77% and 23% owner investment. What is the optimal mix?

Answer 1

The company here is overleveraged since the debt financing is more than the equity financing which increases the risk to the stockholders due to obligatory payments. Also, having higher debt indicates stress on the profits of the firm which may not be appreciated by the owners of the business. An ideal capital mix is one which balances the debt and equity and not a lopsided proportion. The company must pay of the debt in this case by raising more funds through the stockholders. The equity can be slightly higher than the debt but vice versa is not a prudent capital structure.