Valuation

Capital Structure Analysis
Name
Institutional Affiliation
Question
Imagine that you are a venture capitalist, seeking to invest in a new company. In preparation for meetings with prospective clients, you are developing a presentation on the valuation fundamentals of a company. In your initial discussion, include an explanation on why capital structure is so important to a company, and analyze the reasons why firms from different industries have different capital structures and valuations. Also, discuss how an investor can use leverage ratios and industry benchmarks to evaluate the financial health of a company and determine the optimal capital structure.
Response
Capital structure is a vital instrument through which investors gain insights into how a firm balances its equity and debt for both daily operations and long term investments. It important to consider the capital structure as it influences almost of spheres touching on the business including its risk profile, ease of accessing credit, the interests charged for borrowed capital, the expected returns from the lenders and investors, among other factors (Abeywardhana, 2017). Additionally, the capital structure outlines the different claims that different stakeholders have in a firm. It indicates the debt and the equity which a firm has employed to finance its assets and its operations.
Capital structures vary by industry significantly as some industries are difficult to attract debt capital. Seasonal or cyclical industries including the mining firms and farming industries are unpredictable and are unsuitable for debt and the uncertainty to repay their obligations (Abeywardhana, 2017).

In the insurance and banking industries, are more leveraged and the models of business in use require huge amounts of debts. Other industries endowed with private firms, have difficulties raising debt-financing and usually prefer equity. In general, capital structures are greatly determined by the industrial risks, the tax exposure for an industry as highly taxed industries prefer debt financing which is tax deductible and the financial flexibility of the industry.
As illustrated above, the capital structure is dependent on the industry and there is no standard measure across the board. However, an investor can use the leverage ratios to evaluate the financial health of a firm by comparing the performance of the competing firms with the industrial benchmarks. Usually, an optimal capital structure ensures the least cost while maximizing the stock’s price value. Investors should, however, try to avoid most of the leveraged firms depending on the industrial average and benchmarks.
References
Abeywardhana, D. K. (2017). Capital structure theory: an overview. Accounting and finance research journal, 6(1): 133-138