Analysis of the Capital Structure of a company.

Shantnu tyagi Richa singh

Capital structure
Capital structure of a firm is the

mixture of different securities issued by the firm to finance its operation. The capital structure decision of the firm can be characterized as a choice of that combination of debt and equity, which maximizes the market value of the firm.

Contd..
With unplanned capital structure

these companies may also fail to economies the use of their fund. Consequently it is been increasingly realized that company should plan its capital structure to maximize the use of the funds and to be able to

SRS STEELS PVT. LTD

The SRS Steel Pvt. Ltd is a newly

incorporated company and wants to plan an appropriate capital structure. It can issue 15% debt and 11% preference share and has 35% tax rate. The firm initial requirement for funds is Rs4 crores. Equity share can be sold for a net price of Rs25/share.

The capital structure

Alternative Equity Preference Debentures 1 75% NIL 25%

75%

25%

NIL

50%

20%

30%

Analysis of Earning Per Shares

Particulars
Earnings Before Interest & Tax Interest : Profit Before Tax Tax @ 30% Profit After Tax Preference Share Dividend Earnings Available for Equity Share Holders(A) Number of Equity Shares(B)

Option A

Option B
Amount in INR

Option C

9720000
(1500000) 8220000 (2877000) 5343000 Nil

9720000
Nil 9720000 (3402000) 6678000 (1100000)

9720000
( 1800000) 7920000 (2772000) 5148000 (880000)

5343000 1200000

5578000 1200000

4268000 800000

ADDITIONAL INFORMATIONS
Expected sales: - Rs 1,80,00,000

Variable cost: - 36%

Fixed cost: - Rs 18,00,00,000

Expected market price of shares is

assumed of Rs 100 per share Expected dividend to declared is 25% of the expected market price.

Analysis of Weighted Average Cost of Capital

In order to determine the cost of capital from the three

options the company has done the following analysis:

Cost of capital of for Debentures

(1 )

100

 Cost of capital for Preference Shares

= 100
Cost of capital for Equity Shares

= 100

Analysis of Weighted Average Cost of Capital

WACC of Option A
Particulars Option A

Amount Equity Shares 11%Preference Shares 15%Debentures Total 30000000

Weighta ge 0.75

Cost (%) 25

Weighted Cost (%) 18.75

Nil
10000000 40000000 0.25 1

Nil
9.75

Nil
10 28.75

 WACC of Option B
Particulars Option B

Amount Equity Shares 11%Preference Shares 15% Debentures Total 3000000 1000000 Nil 4000000

Weighta ge 0.75 0.25 Nil 1

Cost (%) 25 13.41 Nil

Weighted Cost (%) 18.75 3.35 Nil 22.1

 WACC of Option C
Particulars Option C

Amount Equity Shares 11%Preference Shares 15% Debentures Total 20000000

Weighta ge Cost (%)

0.5 25

Weighted Cost (%)

12.5

8000000
12000000 40000000

0.2
0.3 1

14.19
9.75

2.838
2.925 18.263

Analysis of Leverage
=

Analysis of Leverage
Option A
Option A EBIT Amount Financial Leverage Operational Leverage Combined Leverage 9720000 Contribution 11520000 1.18 PBT 8220000 Particulars

1.185 2.183

 Option B
Option B EBIT Amount Financial Leverage 9720000 Contribution 11520000 1 PBT
9720000

Particulars

Operational Leverage Combined Leverage

1.185 1.185

 Option C
Option C EBIT Amount Financial Leverage 9720000 Contribution 11520000 1.23 PBT 7920000

Particulars

Operational Leverage Combined Leverage

1.185 1.45

CONCLUSION:After evaluating EPS, Leverage and WACC for all the financing options we hereby conclude that Option B is most suitable financing option for the required capital structure fulfilling most of the criteria.

Thank You