capital structure.ppt

Capital structure

expansion

Capital Budgeting Decision

Replacement

Modernization

Need to Raises Fund

Capital Structure Decision

Existing cap structure

Desired Debt-Equity mix

ayout olicy

E##ect on R%S&

E##ect $n Return

E##ect on Cost $F Capital

$ptimum Capital structure

'alue o#  Firm

Components of Capital • Debt Debentures Term Loans Loans • Equity Equity shares Preference Shares Retained Earnings

Capital Structure • The capital structure of a company refers to the mix of the long-term finances used in the organization • !s the proportion of Debt increases in the capital structure of an organization " the ris# of shareholders increases.

Capital structure • Mix of long-term finance used by the firm .  Authorized Capital of Rs. 1 each !ssued" subscribed and paid up capital #resent issue • $%uity at par   • 1&' secured loan (erm loan from ban) *uyers credit

  +"""   ,"""

  1+"/0""   &"""   "&""   1/""" 1"0,"""

actors Affecting the capital structure • Cost of capital • Cash flo2 pro3ections of the company • Size of the company • 4ilution of control • loatation costs

5ptimal capital structure • #rofitability • lexibility • Control • sol6ency

(heories of capital structure • $et income approach %$&' • $et (perating &ncome approach %$(&' • Traditional !pproach • )iller and )odigliani approach %) )'

!n the theories 2e 2ill study *hat is the impact of  change in capital Structure - (n the +alue of the firm - (n the (,erall cost of apital

.d/012

0

.e/E1S .o/3.d421%25S'65 3.e4S1%25S'6 or (1+ +/25S

B= (!Kd"t # S= (!Ke"t

K o = Total cost of capital K d  = = Cost of debt K e  = = Cost of equity   V = Value of the Firm B = Market value of debt S = market value of equity 

7! Approach *hile increasing the le,erage in the firm" the ost of apital %.o' of the firm is decrease )eans the in,erse relationship bet7een . o and le,erage )r De,id Durrande in,ented this approach

7$( !7C5M$ A##R5AC8 !ccording to this theory " if 7e increase or decrease debt in the mix of capital structure - the cost of equity and cost of debt remain same - (,erall cost of capital decrease 7ith increase in Debt - So +alue of the firm increases 7ith use of debt

!ssumptions

• $o tax • Sources of finance equity and debt • $o changes in ris# of in,estors • Retained earning is rein,esting in the firm •  899: di,idend pay-out ratio • $o changes in assets • $et operating income is not expected to gro7 or decline o,er time • 2usiness ris# remain same

hanges in le,erage / changes in .o • increase in le,erage / decrease in .o and increase ,alue of firm • Decrease in le,erage / increase in .o and decrease ,alue of the firm

#e

 ( S t

#o .d

Proportion of Debt

75! Approach *hile increasing or decrease in the le,erage of the firm"

.o remain constant )eans the undefined relationship bet7een .o and le,erage )r De,id Durrande in,ented this approach

7$( 5#$RA(!79 !7C5M$  A##R5AC8 !ccording to this theory " if 7e increase or decrease debt in the mix of capital structure - the cost of equity increases and cost of debt remain same - (,erall cost of capital remain same - So +alue of the firm remain same

hanges in le,erage / $o changes in .o • increase in le,erage / . o remain same and increase . e • Decrease in le,erage / . o remain same and decrease .e

.e

 ( S T :

.o

.d

le,erage

(raditional approach *hen le,erage increase" then at the certain le,el .o decrease !fter that" le,erage increase continuously the . o increase )eans the us relationship bet7een . o and le,erage is in,erse at certain le,el then after co-relationship . Ezra Solomon in,ented this approach

TR!D&T&($!L !PPR(!;

• !ccording to this theory " if 7e increase or decrease debt in the mix of capital structure - the cost of equity and cost of debt remain same up to a degree of le,erage" then they rises sharply - (,erall cost of capital remain same up to a degree of le,erage" then rises sharply - So +alue of the firm remain same up to a degree of le,erage then decrease sharply

Traditional !pproach  %t  sta&e compa'  tradi'& o' equity  :e  ( S T :

:o



3

$

le,erage

:d

 %t $ sta&e 'o &a evera&e) *pti cap) st

 %t + sta&e risk is i' So Ke i'crease

#e #o .d

 ( S t

Proportion of Debt

! company has $(& Rs "99"999 then .e become 8?: %'&f company issues 8