Capital Structure and Capital Budgeting in a Perfect Market

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SHOULD A COMPANY ISSUE STOCKS OR BONDS?

The prominent topic of discussion for this chapter would be whether a company must issue bonds or stock? What should be the manner in which business owners as well as managers should go about the financing of the various projects of their firm? In order to ensure the better understand of the various ways of financing, we will be limiting ourselves to the perfect world scenario under the scope of this chapter. A perfect world or market is one in which no taxes are applicable, no cost for transactions, etc. The idea of the firm value being dependent on the value of projects will be further illustrated under the scope of this chapter. However, it certainly won’t have any sort of dependencies as far as the manner of financing is concerned. This is due to the fact that in this world, any sort of mistake ought to be corrected instantly which means that the equity or debt doesn’t have any sort of interconnected dependencies. The idea of WACC will also be discussed in details under the scope of this chapter. Once we are done with this, the manner in which financing differs in the perfect world and the real world.

The market of product under most circumstances is considered to be imperfect. Under such circumstances, one thing is for certain, i.e. the company’s marginal and mean capital costs will vary. This is something that manager often look into be it the perfect world or the real world. The marginal capital cost of a particular firm would be the average of the capital cost raised to power.

 

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