Operational Efficiency and Financial Obligation †MyAssignmenthelp

Question: Discuss about the Operational Efficiency and Financial Obligation. Answer: Introduction: It is the measure of firms leverage in terms of financial obligation and relates to the companies financing its debt in comparison to the amount of equity financing. High debt to equity ratio is good for the company since it shows the operational efficiency is high as the debt is high as well as equity. The financial industry especially has a high debt to equity ratio due to the fact that it borrows money to also lend money(Corelli, 2017). A high debt to equity ratio shows that a specific firm has been super aggressive in growth financing with the debt it has incurred which may lead to financial distress when its profits or received earnings do not surpass the cost of funds borrowed. Therefore there is identifiable value maximization due to the following; An optimal structure in capital is the best in debt to equity ratio for a company that has its value maximum. Optimal structure of capital gives a balance between the ideal situations of debt to equity range while also minimizing the capital cost of the company. Debt financing is the lowest form of cost of capital due to the fact that there are a lot of tax deductible allowances involved. The value of the stocks of a company is only one part of the total value of the company. An optimal capital structure where stock price is maximized is at the point where WACC is minimum. Thus a company is said to have an optimal capital structure where equity stands at 60% and debt equity is at 40% (Escolano Gaspar, n.d.). The companys total value is comprised of preferred equity holders, common equity holders and debt holders who make up the companys capital structure. Therefore, when calculating a companys value using debt to equity ratio there will be changes in the value of the company especially when any of the component in the capital structure changes. References Corelli, A. (2017). Inside Company Valuation. Cham: Springer. Escolano, J., Gaspar, V. Optimal debt policy under asymmetric risk.