AN EVALUATION OF CAPITAL STRUCTURE AND PROFITABILITY BUSINESS ORGANIZATIONS ( A CASE STUDY OF SOME QUOTED COMPANIES IN NIGERIA)
LITERATURE REVIEW
In the course of this research work, the researcher reviewed work done by different authors on the research topic and related topics. The review started with the implications of capital structure.
2.1 IMPLICATION OF CAPITAL STRUCTURE
Capital structure of a business organisation has its risk and reward implications for equity investors.
- Reward Implication: Debt in the capital structure carries with it tax shield interest on debt are deducted from company’s earnings before being taxed and this reduces the tax liability of the company concerned. According to Sihler (1971:13) adding debt to capital structure in vast majority of instances, increases earnings per share more than does raising the same amount of money from common stock. Once interest is paid, all additional income goes to the existing shareholders, and it does not have to be shared with new comers providers of debt.
- Risk of Financial Distress: A firm’s risk can be divided into two categories risk and business risk. Business risk is the risk inherent in the firm’s operations the uncertainty surrounding revenues and operating costs. According to Ben-Horim (1987-275) financial risk results from the use of debt, which introduce a fixed charge – interest expense. Firms in different industries, facing different degrees of operation leverage may vary with respect to their use of financial leverage. The leverage ratio is regarded as an indicator of risk as high level of debt create a high fixed interest commitment which must be paid to the company irrespective of whether profits are made or not. To quote Samuels etal (1992-441) as the proportion of debt in capital structure increases not only do the risks of equity owners increasing proportions of debt the likelihood of incurring cost of financial distress increase as does the cost of the ultimate financial distress has a cost, and as companies take on higher and higher levels of debt, this cost will have a negative effect on firm value offsetting the value of the tax shield from extra interest payment made.
