Traditional Theory of Capital Structure – Definition

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Traditional Theory Of Capital Structure Definition

The Traditional Theory of Capital Structure is a theory that posits that for an optimal capital structure to exist, the weighted average cost of capital (WACC) must be at a minimum level while the market value of the assets or company is at the maximum level. An optimal capital structure is also regarded as an optimal debt to equity ratio in this traditional theory.

The traditional theory of capital structure maintains that the capital structure of a company ( a mix of debt and equity capital) is an important metric in gauging the value of the company. However, an optimal structure of capital exists when the overall cost of capital of the firm is reduced and the market value of the firm or its assets maximized.

A Little More on What is Traditional Theory Of Capital Structure

According to the traditional theory of capital structure, the optimal capital structure will increase to a certain level before it remains constant and eventually begins to decrease. More borrowings, debts and higher demand for return by equity holders can cause the optimal capital structure to decline. An increase or a cline on the optimal structure of capital affects the value of a firm. Hence, when the overall cost of capital is reduced up to a specific level of debt, the optimal capital structure exists thereby increasing the value of a company.

References  for “Traditional Theory Of Capital Structure

https://www.investopedia.com › Economy › Economics

https://explainry.com/finance/traditional-theory-capital-structure/

https://www.slideshare.net/deekshaq/traditional-theory-of-capital-structure-73900991

Academic research for “Traditional Theory Of Capital Structure                                        

Determinants of capital structure: A case study of listed companies of Nepal, Baral, K. J. (2004). Determinants of capital structure: A case study of listed companies of Nepal. Journal of Nepalese business studies, 1(1), 1-13.

An empirical analysis of capital structure on performance of firms in the petroleum industry in Nigeria, Oladeji, T., Ikpefan, O. A., & Olokoyo, F. O. (2015). An empirical analysis of capital structure on performance of firms in the petroleum industry in Nigeria. Journal of Accounting and Auditing: Research & Practice, 1-9.

Differences in the usage of bootstrap financing among technology‐based versus nontechnology‐based firms, Auken, H. V. (2005). Differences in the usage of bootstrap financing among technologybased versus nontechnologybased firms. Journal of Small Business Management, 43(1), 93-103.

A model of small firm capital acquisition decisions, Van Auken, H. E. (2005). A model of small firm capital acquisition decisions. The International Entrepreneurship and Management Journal, 1(3), 335-352.

The Impact of Capital Structure on Firms’ Performance in Nigeria., Ogebe, P., Ogebe, J., & Alewi, K. (2013). The Impact of Capital Structure on Firms’ Performance in Nigeria.

Effect of capital structure of Nigeria firms on economic growth, Nwankwo, O. (2014). Effect of capital structure of Nigeria firms on economic growth. Mediterranean Journal of social sciences, 5(1), 515.

Capital structure theories: A critical approach, Brendea, G. (2011). Capital structure theories: A critical approach. Studia Universitatis Babes Bolyai-Oeconomica, 56(2), 29-39.

Capital structure theory: A current perspective, Harris, R. S., & Chaplinsky, S. (2008). Capital structure theory: A current perspective.

Capital structure and law around the world, Alves, P. F. P., & Ferreira, M. A. (2011). Capital structure and law around the world. Journal of Multinational Financial Management, 21(3), 119-150.

Capital structure in start-up firms in the conditions of the Czech economy, Chmelíková, G., & Somerlíková, K. (2014). Capital structure in start-up firms in the conditions of the Czech economy. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 62(2), 363-372.

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