Effects Of Capital Structure On The Cost Of Capital Of The Companies Listed In The Nairobi Securities Exchange

ABSTRACT

This study was undertaken to investigate the effect of capital structure on the cost of capital of the companies listed in the Nairobi Securities Exchange. The purpose of this study focuses on the financing function of a finance manager of any firm where before a business initiates, it needs money for operation purposes. There has been a contradiction where debt is referred as being cheaper than equity yet practically many firms avoid debt. This is an issue experienced in many companies hence the need for this study. An optimal capital structure is the mix of the available finances at the most minimal cost possible. All firms normally want to reduce on cost in their operations hence the need to study the effect of capital structure on the cost of capital. Furthermore there has never been an optimal capital structure mix that has ever been established for companies to use hence creating a need of this research. There are various theories explaining the capital structure and also some researchers have realized that there is a relationship between capital structure and the cost of capital while others have realized there is no relationship between capital structure and cost of capital. The study employed descriptive survey design study where this involved collection of information by looking at the financial statements of the forty sampled firms quoted in the Nairobi Securities Exchange. From the analysis of the forty companies listed in the Nairobi Securities Exchange, they were grouped in terms of market category and trend of debt/equity ratio and WACC for each sector were established where the AIMS sector recorded the highest debt/equity ratio and also the lowest WACC. The relationship between the capital structure and the cost of capital was established where a correlation of -0.151 was established indicating that there was negative relationship between the capital structure and cost of capital where an increase in debt there was a decrease on the cost of capital (WACC). From the findings, it was recommended that financial managers should go for more debt for their companies and reduce on the equity financing so as to reduce the company’s cost of capital.