Optimal Capital Structure Of A Firm Towards Increasing Wealth Growth: Evidenced-Based Altman Z-Score And Grover G-Score

Abstract

The study aims to determine the optimal capital structure of a firm toward increasing wealth growth using the Altman Z-score and Grover G-score. Capital structure refers to the specific mix of debt and equity used to finance a company's assets and operations. Equity represents a more expensive, permanent source of capital with greater financial flexibility, while debt is a cheaper, finite-to-maturity capital source that legally obligates a company to make promised cash outflows on a fixed schedule with the need to refinance at some future date at an unknown cost.

The trade-off theory of capital structure suggests that managers should seek an optimal mix of equity and debt that minimizes the firm's weighted average cost of capital, which in turn maximizes company value. However, many practical considerations affect capital structure and the use of leverage by companies, leading to wide variation in capital structures even among otherwise similar companies.

Capital structure is defined as the arrangement of capital by using different sources of long-term funds, including equity and debt. The types of funds raised by a firm include preference shares, equity shares, retained earnings, long-term loans, and debt capital. The optimal capital structure is the perfect mix of debt and equity financing that helps maximize a company's value in the market while minimizing its cost of capital.

An optimal capital structure comprises a balance between equity and debt, with debt including short-term and long-term loans and equity being the combination of common and preferred shares and retained earnings. The formula of capital structure quantifies the amount of equity and outsiders' capital at a point in time. Altman's Z-Score model is a numerical measurement used to predict the chances of a business going bankrupt in the next two years.

The Grover model is a model created by designing and reassessing the Altman Z-Score model. It uses a similar sample to Altman's Z-Score model and includes 70 companies as a sample. The early warning of bankruptcy can be obtained from financial statements, and the earlier the characteristics of bankruptcy are known, the better it is for management to make improvements.

The Grover method, created by Jeffrey S. Grover, predicts bankruptcy by analyzing the Altman Z-Score model. This method uses samples from 70 companies, with 35 going bankrupt and 35 not going bankrupt. The pecking order theory suggests that companies prefer their own funds over debt, acknowledging the risk associated with debt. The theory of compromise suggests that companies can negotiate a cost-benefit analysis to maximize their value.

The agency theory suggests that the optimal permanent capital to maximize a firm's value is one that minimizes agency costs. This study aims to determine the optimal capital structure for increasing wealth growth using evidenced-based Altman Z-score and Grover G-score. The sustainability level will be determined by determining the optimal structure to increase wealth in terms of earnings per share (EPS) and the Altman Z-score and Grover G-score for sustainability.

This is Quantitative research, which uses financial statements of food industry firms and allows for the prediction of future product or service changes. The study focuses on earnings per share (EPS), which is calculated as a company's profit divided by outstanding shares of its common stock.

The Altman Z-score is a tool used to predict whether a company is going bankrupt based on its financial risk and the company's long-term viability. It was introduced by Edward Altman in 1960 and has been proven to provide accurate results of bankruptcy in marketing. The Altman Z-score is a useful tool for evaluating a company's operations and measuring its financial viability in the long term. It is useful when measuring the company's financial status and has been proven to provide accurate results of bankruptcy in marketing.

The Altman Z-score is 72% accurate two years in advance concerning the bankruptcy, with a false negative rate of 6%. In its trial era of 31 years, the accurate rate was between 80% and 90%, one year in advance concerning the bankruptcy, with a false negative rate between 15% and 20%. It is important to judge EPS in relation to the company's share price, such as by looking at the company's P/E or earnings yield.

An optimal capital structure is the best mix of debt and equity financing that maximizes a company's market value while minimizing its cost of capital. This balance between financial flexibility and debt is crucial in determining the optimal capital structure. However, many practical considerations affect capital structure and the use of leverage by companies, leading to wide variation in capital structures even among otherwise similar companies.

This study evaluates the financial condition of 28 technology companies using the Grover model, which takes into account three important financial ratios. The study found that 28 companies exhibited good financial performance between 2016 and 2020. The optimal capital structure involves considering factors such as weighted average cost of capital, risk and expected return, business risk, industry averages, potential cost of financial distress, company's tax status, and application of financial models.

The EPS (Earnings per Share) ratio is a profitability indicator that helps investors determine a company's value. However, a higher EPS is not a guarantee of future performance. The quality and reliability of a company's EPS ratio can be influenced by how the company reports earnings and expenses.

A score below 1.8 signals a company is likely headed for bankruptcy, while companies with scores above 3 are not. Altman's Z-Score can help measure a business organization's financial health by using multiple balance sheet values. Grover's algorithm has potential applications in cryptography, machine learning, optimization, and database search. However, it has limitations, such as the requirement of a quantum oracle, and only provides a quadratic speedup.

For future research, Altman's and Grover's models should be used to measure company performance from different sectors, and the search for an optimal capital structure will continue as there are no permanent capital structures.