THE IMPACT OF OPTIMAL CAPITAL STRUCTURE ON THE MAXIMIZATION OF COMPANY’S MARKET VALUE OF TEXTILE INDUSTRIES OF PAKISTAN.

Abstract

The primary objectives of the all business organization in corporate finance are to maximize the market value firm and also to maximize the shareholders’ wealth. This objective can be achieved by attaining and maintaining the optimal capital structure of the firm. The puipose of this study to examine through empirical study that this concept is applicable or not on textile firms listed at stock exchanges of Pakistan during the last 10 years. It has been a long critical debate on this topic, lot of research has been carried out by the scholars but the consensus could not be done. The subject is getting more importance with the passage of time for the management of company with the passage of time. The question is that management can use this theoretical approach to achieve these objectives. In this respect two school of thought came forward and presented various theories, arguments and point of view in favor and against it. Research studies have been carried out time to time in the past but the topic is still deliberated among the scholars. According to optimal capital structure theory, the debt equity ration effect the company cost of capital and subsequently it value maximization and also its share price in the stock market. The optimal capital structure is comprised on ordinary equity shares, preferred stock and long term debts. The optimal capital structure is reached where the weighted average cost of capital of the company is minimized and the value of the company would be maximum together its market price of share according to traditional management writers Gordon and Walter. The modern school of thought (Modigliani and Miller) claimed that there is no concept of optimal capital structure. They believed that there is a perfect market environment. According to them WACC does not change in response to change in debt equity ratio thus they rejected the concept of optimal capital structure of the company. It is important for the company to apply DCF rate of return for discounting the new project instead of way of funding the project. The puipose of this thesis is to examine the relationship between the debt equity ratio, capital structure of the company and market value maximization, of textile companies of Pakistan listed at stock exchanges of Pakistan. Debt equity ratio financial leverage measures the financial risk of the company. The increase in debt equity ratio, increases the financial risk of the company. The WACC of the company depends on capital structure of the company. Theoretical at minimum WACC there would be optimal capital structure and the market value of company would be maximum. For this purpose 9 textile company the listed at stock exchange were selected to evaluate the relationship between the capital structure of company and the market value of the company, by applying Correlation analysis for the period of 10 years from 2005 to 2014.