Capital Structure

The mix of debt and equity a company uses to finance its operations and growth.

Accounting & Statements

Definition

Capital structure determines a company's financial risk profile and cost of capital. More debt increases financial leverage (amplifying returns and risks) but provides a tax shield. The optimal capital structure minimizes WACC by balancing the tax benefits of debt against the costs of financial distress. Modigliani-Miller theorem establishes the theoretical framework, while trade-off theory and pecking order theory guide practical decisions.

lightbulb Example

Company A: 30% debt, 70% equity—conservative, lower risk, higher WACC. Company B: 60% debt, 40% equity—aggressive, higher risk, lower WACC due to tax shield. Company B earns higher ROE in good times but faces greater distress risk in downturns.

verified_user Key Points

  • Mix of debt and equity financing
  • More debt = higher leverage = higher risk + lower WACC (to a point)
  • Optimal structure minimizes WACC
  • Modigliani-Miller provides theoretical framework

menu_book Browse Glossary

Explore 1000+ financial terms with definitions, formulas, and examples.

search Browse All Terms

Put Your Knowledge to Work

Open a free demo account and apply what you've learned with $50,000 in virtual capital.

Open Account