Capital structure of an enterprise shows which of the following?

Debt-equity ratio

The correct answer is option 4- Debt-equity ratio.

Capital structure refers to the mix between owners and borrowed funds. It can be calculated as debt-equity ratio i.e., Debt / Equity or as the proportion of debt out of the total capital i.e., Debt / (Debt+Equity).

Debt and equity differ significantly in their cost and riskiness for the firm. The cost of debt is lower than the cost of equity for a firm because the lender’s risk is lower than the equity shareholder’s risk, since the lender earns an assured return and repayment of capital and, therefore, they should require a lower rate of return. Additionally, interest paid on debt is a deductible expense for computation of tax liability whereas dividends are paid out of after-tax profit. Increased use of debt, therefore, is likely to lower the over-all cost of capital of the firm provided that the cost of equity remains unaffected.