Capital structure is used to represent the proportionate relationship between debt and equity .Equity includes paid up share capital ,share premium and reserve and surplus .capital structure is the composition of debt and equity security that comprise a firm’s financing of its assets . Both debt and equity securities are used in most large corporation .the choice of the amount of debt and equity is made after a comparison of certain characteristics of each kind of security of internal factor related to the firm’s operation and of external factor that can affect firm. Capital is the blood of the business .A business firm can’t run their business without capital .
Effective capital structure is the key to successful business operation .capital structure of the firm affects profitability positon and cost of capital. So, every business firm has to maintain its capital structure effectively. It’s the one of the key areas of finance where the management is mainly concerned.
Firstly we must decide what we mean by a good capital structure .this would be a capital structure, which results a low overall cost of capital for the company that trends a low overall rate of return need to pay on fund provided .If the cost of capital is low, than the discounted value of future cash flows generated by the company is high resulting a high overall company value. the objectives is therefore to find the capital structure that gives the lowest overall cost of capital and subsequently , the highest company value.