OPTIMAL CAPITAL STRUCTURE: EVALUATING THE DETERMINANTS AND TRENDS IN THE AUTOMOBILE INDUSTRY IN PAKISTAN

Abstract

This study focuses on evaluating the determinants and trends in the capital structure of the automobile industry, with a specific emphasis on the case of Toyota Motors and Atlas Honda. The research highlights the significance of adopting an optimal capital structure to mitigate risks and prevent potential damages, such as insolvency resulting from the inability to repay debt. The study emphasizes the need for firms to carefully determine the appropriate level of debt financing that aligns with their unique circumstances. Debt financing offers advantages such as easier accessibility and lower cost of capital compared to equity financing, along with the benefit of a tax shield. However, firms must consider the financial costs associated with debt, particularly the interest payments required to service borrowed funds. On the other hand, equity financing entails its own cost in the form of the cost of equity, which includes the opportunity cost. By analyzing the financial data of Toyota Motors and Atlas Honda, it was observed that these companies maintained a debt-to-capital ratio of less than 50%. This suggests that they rely less on external sources for fund generation. The findings support the hypothesis that a capital structure with less than 50% debt is preferable for firms. Consequently, firms should carefully evaluate their debt-to-equity ratio and strive to maintain a balance that aligns with their financial goals and risk tolerance. This research provides valuable insights into the determinants and trends in capital structure within the automobile industry. It underscores the importance of making informed decisions regarding debt and equity financing and highlights the need for ongoing evaluation and optimization of capital structure to enhance financial stability and maximize long-term profitability.