A STUDY REPORT ON
CAPITAL STRUCTURE
P R ES EN T ED BY:
N A M E : A L L A M SH I VA N I
E M A I L : A L L A M SH I VA N I 1 4 @ G M
[Link]
ROLL NO: 228123672029
C O L L EG E C O D E : 2 2 8 1
ARADHANA SCHOOL OF
B U S I N E SS M A N A G EM EN T,
H Y D ER A B A D
LIST OF CONTENTS
1. MEANING OF CAPITAL STRUCTURE
2. INSTANCE OF CAPITAL STRUCTURE
3. SIGNIFICANCE
4. FACTORS INFLUENCING
5. VARIOUS APPROACHES
6. CONSCLUSION
MEANING OF CAPITAL STRUCTURE
The proportion of various long term sources of finance in capital of an enterprise to
regulate its ongoing operations and continue to grow.
Long term sources of finance:
-Equity share capital
-Preference share capital
-Debentures
-Reserves & Surplus
-Bonds, etc.
To understand this concept in a better way, let us consider a basic example.
- For construction of building we require bricks, cement, iron, etc. and building's
structure can be obtained by combining all these things together.
Similarly, for business there's structure for capital, that comprises various sources of
finance mentioned earlier. For instance,
Capital employed of an entity :- 200 crore
Equity capital :- 100 cr
Preference capital :- 50 cr
Debentures :- 50 cr
Proportioning sources of finance
Amount in crore
50
100
Equity
Preference
Debenture
50
The above apportionment of sources of finance ratio comes 100:50:50 i.e
2:1:1, this ratio is technically known as structure of capital .
Significance of CAPITAL STRUCTURE
Maximi
ze
returns
Control Reduce
over Significance cost of
Entity capital
Minimiz
e the
risk
❊Significance of Capital Structure
It determines the risk assumed by the firm and helps in taking
appropriate steps to minimize the risk factor.
It prevents under and over capitalization and helps in
maintaining sound capital structure for maintaining operations
of entity.
It determines cost of capital.
It affects flexibility & liquidity of firm
It affects control of ownership
It provides maximum wealth returns to the shareholders.
It maintains control over organisation
A good capital structure ensures that the available funds are
used effectively
◈ Glimpse of factors affecting Capital
structure
Utilisation of Nature and size Flexibility &
Funds of firm control
Growth &
Market Legal
stability of
conditions requirements
sales
Factors influencing Capital Structure
Financial managers should plan an optimum capital structure of his company.
That is possible when market value per share is maximum.
Hence for sound Capital Structure, there are few factors to be kept in view while
planning, they are as follows :
Return – maximize return to share holders
Risk – minimise and avoid excessive debt
Flexibility – can be able to adapt to changing situations.
Capacity – within debt limitations of company
Control – chance of dilution of ownership
Capital market conditions – business cycles
Legal requirements – act in accordance with changes in legal norms
CAPITAL STRUCTURE APPROACHES
CAPITAL STRUCTURE THEORIES:
They explore the relationship between capital structure and
value of the firm.
RELEVANT IRRELEVAN
THEORY T THEORY
doesn’t
Affects affect
value of value of
firm firm
- NI APPROACH - NOI APPROACH
- TRADITIONAL - MM APPROACH
APPROACH
NET INCOME APPROACH
NET INCOME APPROACH:
PRESENTED BY DAVID DURAND
In this approach, he suggests that change in financial leverage
results in change in capital cost.
More debt –> high capital structure –> less cost of capital–> high
value of the firm.
Here cost of capital is the key of Capital structure.
ASSUMPTIONS
- Business risk is assumed to be constant and independent
- Firm has 100% dividend paying policy
- Here firm employs only two capitals : Debt and Equity
NET OPERATING INCOME APPROACH
Presented by DAVID DURAND
- Just opposite to NET INCOMEAPPROACH
Market value of firm not affected by change in Capital structure
Market value can be calculated as NOI
overall cost of capital
If NOI & Ko are constant then V is constant
V = NOI/Ko
Ko = Cost of capital and depends upon business risk of firm
ASSUMPTIONS
- No split between debt and equity
- Debt capitalisation rate is constant
- Corporate income tax does not exist
TRADITIONAL APPROACH
This approach is also known as intermediate theory
It is an immediate between NI & NOI Approach
According to this approach, Value of the firm can be increased
or cost of capital can be reduced by a judicious mix of debt and
equity capital.
It is said in theory that, firm value increases to a certain level of
debt, then remains constant and eventually tends to decrease if
there are too much of burrowing
MODIGILANI – MILLER (MM) APPROACH
Similar to NOI Approach
It is said in this theory that, in absence of taxes, firm’s market value
and capital cost remains irrelevant to change in Capital Structure.
ACCORDING TO THIS THEORY, VALUE OF FIRM DETERMINED BY
PRESENT VALUE OF FUTURE EARNINGS
ASSUMPTIONS
Perfect cap market – All shares are traded in perfect capital market
Risk – variability of net operating income
No tax
Full payout
CONCLUSION
Capital structure is a fundamental concept in finance, and
it plays a crucial role in success of a business. Business
owners must consider various factors before making an
informed decision on their optimal capital structure.
Once a business finds its ideal financing mix, owners can
use the benefit of each financing option to grow and scale
their business without limitations.
The optimal mix of debt and equity helps to balance the risk
and cost of capital, profitability, influencing strategic
decisions on expansion & maximize shareholders wealth.