Financing Structure - General Understanding because, General, important, companies, advantage

zbird2134

General Understanding:

Why is Financing Structure so important in Comparing firms? Is it because unlevered companies can take on more debt ( competitive advantage)?

ayodayo

Capital structure is one very important factor in comparing firms. Firms with large amount of euity capital than debt have a higher WACC Vs those that have higher debt in their capital structure because of the tax savings on the cost of debt. Higher WACC reduces the value of the firm because - a) higher denominator in FCFF valuation model, and b) higher equity capital providers require higher returns resulting in higher risk.

This is why analysts prefer to use optimal (or target) capital structure for analyzing firms in specific industries to make sure they are comparing apples to apples.