Introduction

A capital structure is nothing one can touch or see in reality, but it is measured using according and financial information. It can hence be calculated for organisation sophisticated enough to portray their operations in the form of balance sheet. From this it follows that the capital structure is socially constructed and thus not always an objective and uncontroversial measure. On capital structure decision Miller and Modigliani use the terminology of debt and equity when categorising companies’ liabilities. Debt then refers to liabilities bearing a residual, or implicit, cost. Debt, as it is used here, refers to interesting to risk bearing capital. The fundamental deference between debt and equity is that debt financing is based on a contractual relationship the debt holder and the as a legal entity. This provides the debt holder with certain legal right. The investor provide equity to the company and unlike debt holder, investor lack contractual relationship with other stakeholder (including debt holder) have been fulfilled. Because share holders are not garneted anything they take a greater risk and hence we can expect them to ask for a higher return than debt holders.

In essence, equity consists of capital invested by investor (typically common stock and preferred stock) and earning after dividends from previous year (retained earnings). Debt consists of numerous different items such as for example bank loan, issued corporate bonds, convertible securities, deferred tax liability, and supplier credits. Often the debt liability is subdivided into short term and long term debt. It’s based on Solvency, Debt ratio, and Interest rate. The balance sheet presented in the annual report contains the book values of assets and liabilities. The market value stems from trading in financial markets where investor estimated future cash flows from the company’s current and expected future project. Existing assets might be worth more than their historical acquisition cost, and they can be expected to generate substantial future cash flows. The market value of debt can differ from book value, usually to a much lesser extent.

Research problem and why this research problem is important.

This problem is of vital importance because; imagine if the circumstances were such that capital structure did not matter. That would suggest that wealth could be created in the board room irrespective of efficient production and logistics etc. This could be done through the manipulation of the gearing ratio at the board level by releasing debt and equity as appropriate. However, this would not be in the long term benefit of shareholders. By insinuating that capital structure is important, indeed, vital to wealth creation, that requires managers to perform well, ensure efficient management and production and the long term success of the company. That is why capital structure is important!

Aim and Objectives

Utilising the classical theories as started by Modigliani and Miller (1958) et al, this paper looks to consider the impact of changes in capital structure (also referred to as leverage,) and attempts to correlate these changes with market value impacts. Further, the practical implications of the notion of optimal capital structure are considered as proposed by BHP Billiton plc. The research seems to suggest that a strong business model, coupled with a constant and healthy cash flow remain the fundamental determinants of a company’s long term success.

The role of finance methodology and the different requirements of stake holder, this method in sequence and efficient market hypothesis have to fulfil. And analyse between capital value and market value, with taxation and bankruptcy theory. Aim of research in this area which capital structure model is use full for BHP Billiton plc, long term success, and how much exact label of gearing is required because this is mining company.

Literature Review

There is an Extensive theoretical literature concerning optimal capital structure of BHP Billiton plc. However, there is little empirical evidence of a relation between changes in capital structure and firm value. In the best known test of an optimal capital structure model, Miller-Modigliani reported evidence of a positive relationship between firm value and leverage which they attributed to a debt tax shield effect of this firm. Their results are suspect, however, because of statistical problems they encountered when attempting to adjust for differences in the firms’ asset and capital structures. Since only regulated firms were examined, there is also some concern that their empirical findings were caused by the regulatory environment in which these firms operate. No strong evidence of a relation between a firm’s value and the size of its debt tax shield and controversy between debt and equity ratio has been uncovered since the Miller-Modigliani study. This study estimates the impact of a change in debt level on firm values. Two forms of capital structure change are examined: issuer exchange offers, and recapitalizations. The results indicate that both stock prices and firm values are positively related to changes in debt level and leverage; senior security prices are negatively related to these capital structure change variables. This evidence is consistent with models of optimal capital structure and with the hypothesis that debt level changes release information about changes in firm value.

Cost of capital

In percent

Ke.

(A) (C) WACC

(B)

Kd

0 x Label of gearing

The traditional approach to capital structure

In tradition approch we evaluat the financial assets and analys between cost Equity and cot of Debt.

And when we calculate the WACC in this area i find the exact label of capital structure.

The static capital structure model

Market Value of Share