Capital Structure Ppt 5js61
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CAPITAL STRUCTURE
By : ANUSHRI NEGI MMS-FINANCE
CONCEPT OF CAPITAL
The total capital can be divided into two components: 1. debt/borrowed capital 2. equity/ownership capital
WHAT IS “CAPITAL STRUCTURE”?
“Capital structure of the company refers to the composition or make-up of its capitalization and it includes all long-term capital resource viz: loans, reserves, shares and bonds.” - Gerestenbeg
CAPITALISATION,CAPITAL STRUCTURE & FINANCIAL STRUCTURE
Capital structure = Long-term debt + Preferred stock + Common equity
Financial structure = Current Liabilities + Long-term debt + Preferred stock + Common equity
FORMS OF CAPITAL STRUCTURE
Capital structure with equity share only,
Capital structure with equity share & preference share,
Capital structure with equity share & debenture,
Capital structure with equity share, debenture & preference share.
IMPORTANCE OF CAPITAL STRUCTURE
“It is true that capital structure cannot affect the total earnings of a firm but it can affect the share of earnings available for equity shareholders.”
OPTIMAL CAPITAL STRUCTURE
“ An Optimal Capital Structure is one that minimizes the firm’s cost of capital and thus maximizes firm value (and the wealth of its owners).”
THEORIES OF CAPITAL STRUCTURE
The theories on capital structure suggests the proportion of equity and debt in the capital structure. Different Theories of Capital Structure
(1) Net Income Approach (2) Net Operating Income (NOI) Approach (3) Traditional Approach (4) Modigliani-Miller Model (5) Trade off theory (6) Pecking Order Theory
(1) Net Income Approach
Suggested by David Durand V=S+D
(2) Net Operating Income Approach
Suggested by David Durand The total value of the firm will not be affected by the composition of capital structure. V = EBIT / Ko
(3) Traditional Approach
It takes a mid-way between the NI approach and the NOI approach.
(4) Modigliani – Miller (MM) approach
Absence of taxes -Debt-equity mix is irrelevant in determining the total value of the firm. -Two firms identical in all respects except their capital structure, cannot have different market values or different cost of capital.
Corporate Taxes exits -The value of the firm will increase or the cost of capital will decrease with the use of debt due to tax deductibility of interest charges. -
FACTORS DETERMINING CAPITAL STRUCTURE
Component cost of capital
Period of finance
Nature and size of the firm Asset structure
Operating leverage
Management attitudes
Cash flow stability
Corporate tax rate
Purpose of financing
Legal requirements Capital market conditions
Growth and stability of sales
Debt covenants
Flexibility
Control
CHANGES IN CAPITAL STRUCTURE
To restore balance in financial plan
To simplify capital structure
To suit investors need
To capitalize retained earnings
To clear default on fixed cost securities
To facilitate merger & expansion
CAPITAL STRUCTURE POLICIES IN PRACTICE NATURE OF INDUSTRY- RESPONSE Electrical “We try to maintain a debt-equity ratio of less than 2:1 because it is the government norm.” Chemicals “Ours is very conservative debt policy. We borrowed funds only in recent years for some expansion purpose.” Fertilizer “We don’t have a specific debt-equity policy---it depends. Aluminiums “Our goal is to maintain the debt-equity ratio within a certain level which, of course, is kept confidential.” Consumer electronic “Our focus is more on production and technology. Finances didn’t pose much a problem. We don’t follow a rigid capital structure policy.” Diversified “We finance project-by-project basis. There is no long range capitl structure in mind.” Automobile “We follow as per government rule that is 2:1”
THE CASE OF “RELIANCE INDUSTRIES LIMITED” “Reliance industries Limited has arguably been the most successful company in the Indian private sector in raising finances for its ambitious projects from time to time. It seems to have mastered the knack of obtaining finances at attractive for ing its aggressive investment plans.’
CONCLUSION “ There cannot perhaps be an exact mathematical solution to the decision on capital structuring.”
“Human judgment plays an important role in analysing the conflicting forces before a decision on appropriate capital structure is reached.”
Thank You!!
By : ANUSHRI NEGI MMS-FINANCE
CONCEPT OF CAPITAL
The total capital can be divided into two components: 1. debt/borrowed capital 2. equity/ownership capital
WHAT IS “CAPITAL STRUCTURE”?
“Capital structure of the company refers to the composition or make-up of its capitalization and it includes all long-term capital resource viz: loans, reserves, shares and bonds.” - Gerestenbeg
CAPITALISATION,CAPITAL STRUCTURE & FINANCIAL STRUCTURE
Capital structure = Long-term debt + Preferred stock + Common equity
Financial structure = Current Liabilities + Long-term debt + Preferred stock + Common equity
FORMS OF CAPITAL STRUCTURE
Capital structure with equity share only,
Capital structure with equity share & preference share,
Capital structure with equity share & debenture,
Capital structure with equity share, debenture & preference share.
IMPORTANCE OF CAPITAL STRUCTURE
“It is true that capital structure cannot affect the total earnings of a firm but it can affect the share of earnings available for equity shareholders.”
OPTIMAL CAPITAL STRUCTURE
“ An Optimal Capital Structure is one that minimizes the firm’s cost of capital and thus maximizes firm value (and the wealth of its owners).”
THEORIES OF CAPITAL STRUCTURE
The theories on capital structure suggests the proportion of equity and debt in the capital structure. Different Theories of Capital Structure
(1) Net Income Approach (2) Net Operating Income (NOI) Approach (3) Traditional Approach (4) Modigliani-Miller Model (5) Trade off theory (6) Pecking Order Theory
(1) Net Income Approach
Suggested by David Durand V=S+D
(2) Net Operating Income Approach
Suggested by David Durand The total value of the firm will not be affected by the composition of capital structure. V = EBIT / Ko
(3) Traditional Approach
It takes a mid-way between the NI approach and the NOI approach.
(4) Modigliani – Miller (MM) approach
Absence of taxes -Debt-equity mix is irrelevant in determining the total value of the firm. -Two firms identical in all respects except their capital structure, cannot have different market values or different cost of capital.
Corporate Taxes exits -The value of the firm will increase or the cost of capital will decrease with the use of debt due to tax deductibility of interest charges. -
FACTORS DETERMINING CAPITAL STRUCTURE
Component cost of capital
Period of finance
Nature and size of the firm Asset structure
Operating leverage
Management attitudes
Cash flow stability
Corporate tax rate
Purpose of financing
Legal requirements Capital market conditions
Growth and stability of sales
Debt covenants
Flexibility
Control
CHANGES IN CAPITAL STRUCTURE
To restore balance in financial plan
To simplify capital structure
To suit investors need
To capitalize retained earnings
To clear default on fixed cost securities
To facilitate merger & expansion
CAPITAL STRUCTURE POLICIES IN PRACTICE NATURE OF INDUSTRY- RESPONSE Electrical “We try to maintain a debt-equity ratio of less than 2:1 because it is the government norm.” Chemicals “Ours is very conservative debt policy. We borrowed funds only in recent years for some expansion purpose.” Fertilizer “We don’t have a specific debt-equity policy---it depends. Aluminiums “Our goal is to maintain the debt-equity ratio within a certain level which, of course, is kept confidential.” Consumer electronic “Our focus is more on production and technology. Finances didn’t pose much a problem. We don’t follow a rigid capital structure policy.” Diversified “We finance project-by-project basis. There is no long range capitl structure in mind.” Automobile “We follow as per government rule that is 2:1”
THE CASE OF “RELIANCE INDUSTRIES LIMITED” “Reliance industries Limited has arguably been the most successful company in the Indian private sector in raising finances for its ambitious projects from time to time. It seems to have mastered the knack of obtaining finances at attractive for ing its aggressive investment plans.’
CONCLUSION “ There cannot perhaps be an exact mathematical solution to the decision on capital structuring.”
“Human judgment plays an important role in analysing the conflicting forces before a decision on appropriate capital structure is reached.”
Thank You!!
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