Distinction between Financial Structure and Capital Structure
We can make a purist distinction in terminology between Capital Structure and Financial Structure.
Strictly speaking the Financial Structure includes all sources of financing, including short-term, while the Capital Structure is based solely on long-term instruments.
The problem that arises is that, in popular parlance, people referring to one or the other, but this is not entirely correct. Financiers must distinguish clearly between them.
The work of Miller and Modigliani refers to the Capital Structure, exclusively.
Companies use different sources of long-term financing to fund their operations. These instruments are primarily the issue of shares and long-term bonds, in any case exceed five (5) years.
Can we change the value of a company simply by changing the proportions of long-term instruments of a company?
In 1958, two remarkable researchers Franco Modigliani and Merton Miller came to make important findings with regard to this fundamental question.
First, they found that in a world without friction, ie, no taxes, no transaction costs and no other constraints, modifying the ratio of stocks and bonds, does not alter the cost of capital. If unchanged, the cost of capital, since then, the company value is not modified.
For its part, in a world with friction (with taxes), the value of the company grows proportionately with the leverage, ie the extent to which the debt increases. This is mainly due to the weighted average cost of capital is reduced as a result of tax relief on interest payments on debt.
As above, one could conclude that it is worth being in debt to the extent possible. In practice, if there is a limit at which firms borrow because beyond this limit, the demands on cash flow are such that their value instead of increasing, decreases.
This leads us to affirm that there is a perfect combination of the various instruments of long-term financing, at which point the company says operates with an optimal capital structure.
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