Capital Structur

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Presented By

Dines

hChau

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AgendaDefinition

Capital Structure Consists Of Owned Funds Borrowed Funds

Factors Influencing Capital Structure Internal Factors External Factors

Assumptions

Theories of Capital Structure¤ Net Income (NI) Theory¤ Net Operating Income (NOI) Theory¤ Traditional Theory¤ Modigliani-Miller (M-M) Theory

Format Of Evaluation Of Alternative Capital Plans

A Firm has the choice to raise funds for financing its projects with the following choices:

(a)Only with equity shares.(b)With equity & preference shares.(c)With equity shares & debentures.(d) With equity, preference shares &

debentures.

Definition

“Capital structure of a company refers to the make-up of its capitalisation and it includes all

long term capital resources, viz :- shares, loans, reserves and bonds”

Gerstenberg

Capital Structure Consist Of :-

1) Owned funds: It belongs to the proprietors.

It includes share capital, free reserve & surplus.

2) Borrowed funds: It consist of long-term borrowing from

outside sources.

It consists of debentures,bonds & long term loans provided by banks and term

lending institutions.

Factors Influencing Capital Structure

♠ Internal Factors

♠ External Factors

Internal Factors

Size of Business Nature of Business Cost of capital Risk Factor Control factor Operating Ratio

External Factors

General Economic Conditions Nature of Investors Level Of Interest rates Taxation Policy Policies of Financial Institutions Cost of Financing Seasonal Variations Economic Fluctuations Nature of Competition

Assumptions

There are only two source of funds. There are no corporate taxes. The dividend-payout ratio is 100. The total assets remain constant. Firms total financing remain constant. Risk perception of the investor remains constant. The operating profit (EBIT) are not expected to grow. Perpetual life of the firm. Return on Investment remains constant. Investor’s profits remains constant.

Theories of Capital Structure

Net Income (NI) Theory

Net Operating Income (NOI) Theory

Traditional Theory

Modigliani-Miller (M-M) Theory

Traditional Theory

¤ This theory was propounded by Ezra Solomon.

¤ According to this theory, a firm can reduce the overall cost of capital or increase the total value of the firm by increasing the debt proportion in its capital structure to a certain limit. Because debt is a cheap source of raising funds as compared to equity capital.

Assumptions of Traditional Theory

Firm has a perpetual life.

Corporate income tax does not exist.

Company follows a 100 % dividend pay out policy.

Operating income of company not to grow over time.

Effect of inducing more debt If however, the amount of debt is

increased further, two things are likely to happen:

1)The investment in the firm would become very risky to the creditors

2)the expectations of investors in terms of returns on their investment may increase & share price of the company may decrease.

Optimum Capital Structure

Another variant of the traditional approach suggests that there is no one single capital structure,but,there is a range of capital structures in which the cost of capital(Ko) is the minimum and the value of the firm is the maximum. In this range, changes in leverage have very little effect on the value of the firm.

Format of Evaluation of Alternative Capital Plans