Read the following case study and answer question.

Aninjey is a CEO of Alfa Ltd. He is running a shoe business where his company is manufacturing canvas shoes, made up of breathable t-shirt fabric. His business is having a good liquidity position. He has already issued 200 equity shares earlier and has a company policy of paying regular dividends to its shareholders. He wants to expand his business and for that he required 100 crores. He asked his Finance Manager to prepare a financial blueprint of the same in order to have the right debt-equity ratio, so that a right financial balance can be maintained.

Give the right formula to calculate the capital structure of the company.

$\frac{Debt}{Debt\, +\, Equity}$

The correct answer is option (1)- $\frac{Debt}{Debt\, +\, Equity}$.

The right formula of calculating capital structure is $\frac{Debt}{Debt\, +\, Equity}$.

Capital structure refers to the mix between owners and borrowed funds. These shall be referred as equity and debt in the subsequent text. 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.