Week 10: Optimal Capital Structure

Optimal Capital Structure

Optimal capital structure is categorized as one of the best ratio from debt-to-equity ratio and it can give understanding of the next step of risk in company for the potential investor. The theory of equity financing gives states that in equity financing is more less risky than a loan and also will brings more credibility to our company. Through the equity financing the investor expected in a long-term view return, by then the company will have more cash for expanding their business and accomplish the objective of company. Moreover, in equity financing the company is not required to payback the investment to the investor in the case if the business of the company fail. In addition, the company should consider the disadvantages from equity finance like the investor needs to have the some of the ownership in the company, it is not easy to find the loyal investor for the company, and before the company making a decision, they should discuss with their investor first.

In the case of debt financing, the company can choose for their loan period (short or long term). The company could see the exact interest and the proper principle of the loans and cannot be changed, besides that; the interest from the loan is tax deductible. The most important thing from debt financing is the bank or lending firms does not have a right to take give suggestion or take any decision in the company, because they does not have any ownership in the company. However, the company should consider the period of time, which already sets before, if the company relies to much to the debt, it will make the cash flow of the company got a big problem, and paying debt is not easy in a business, since the debt will be in a large amount and automatically the interest will be high as well.

Nonetheless, the company should consider disadvantages of both ways. In the case of Scottish Widows Investment partnership, this is part of the business from Lloyds TSB group, one of the largest banks in United Kingdom. Lloyds TSB sold 20% stake in wealth manager St James’s place, in order to increase their market price. Based on my opinion, Lloyds TSB choose to take lower debt ration, because they thing with the low debt of ration the investor will more attractive to invest to the Scottish Widows investment. The investor might think the company could handle every situation and finally the investor will get higher rate of return. To conclude, I think Lloyds TSB do the right thing to attract the investor in order to optimize their capital to expand their business or in the case I am the one who will invest to the company, definitely I will invest to the Scottish widows investment, since the company shown a good prospectus for the long term and short term.