What is the optimal capital structure for PS Partner, a private company, in order to maximize the value of the firm?

Abstract

This thesis is a study aimed to find the optimal capital structure for PS Partner, a private company active within consulting and recruitment. Since financing decisions and structural partitioning between retained earnings, equity and debt will affect the market value and hence the cost of capital, this study focused on estimating parameters to find an optimal leverage ratio for financing and thereby maximize the value of the firm. The optimal capital structure for the private company was estimated using the trade-off theory by weighing the effects of leverage from the benefit of a tax shield against the disadvantage of increasing the risk for financial distress. Owners of private companies often have a majority of their current wealth invested in the company, whereas they lack financial diversity compared to investors of public companies. It has been argued that several economic models are originally designed for public firms and therefore need to be adjusted prior to use in private firms, e.g. to compensate private investors for the increased risk. In this study, the optimal capital structure was estimated to ≈ 30 % debt of the firm’s value, which generated a market value of approximately 20.4 MSEK, an increase of 5,4% compared to the present value. Without leverage, the required return on equity was estimated to 12 %. At the optimal capital structure, the cost of capital was estimated to 11% with a required return on equity of 15%.