Capital Structure

A way a corporation finances itself through

some combination of equity and debt.

The capital structure should be designed

with the aim of maximizing the market
valuation of the firm in the long run.

MARKET RISK

The possibility of loss to a bank/firm/company due to

change in market variables

Market

Risk is also referred to as systematic risk or

non-diversifiable risk

 The

possibility for an investor to experience losses

due to factors that affect the overall performance of
the financial markets

The

risk that a major natural disaster will cause a

decline in the market as a whole is an example of
market risk. Other sources of market risk
include recessions, political turmoil, changes in
interest
rates
and
terrorist
attacks.

BUSINESS RISK

The possibility that a company will have lower than

anticipated profits, or that it will experience a loss rather
than a profit.
Business risk is influenced by numerous factors, including
sales volume, per-unit price, input costs, competition,
overall economic climate and government regulations.
A company with a higher business risk should choose a
capital structure that has a lower debt ratio to ensure that
it can meet its financial obligations at all times.

Business risks can major by the influence by two major

risks: internal risks (risks arising from the events
taking place within the organization) and external
risks (risks arising from the events taking place outside
the organization).
Internal risks arise from factors such as human factors
(talent management, strikes), technological factors
(emerging technologies), physical factors (failure of
machines, fire or theft), operational factors (access to
credit, cost cutting, advertisement).
External risks arise from factors such as economic
factors (market risks, pricing pressure), natural factors
(floods, earthquakes), political factors (compliance and
regulations of government)

FINANCIAL RISK
The possibility that shareholders will lose money when
they invest in a company that has debt, if the
company's cash flow proves inadequate to meet its
financial obligations.
Financial Risk as the term suggests is the risk that
involves financial loss to firms.
Financial risk generally arises due to instability and
losses in the financial market caused by movements in
stock prices, currencies, interest rates and more.

Determinats of Capital Structure

Decisions
Business Risk
Excluding debt, business risk is the basic risk of the company's operations. The
greater the business risk, the lower the optimal debt ratio.
Company's Tax Exposure
Debt payments are tax deductible. As such, if a company's tax rate is high,
using debt as a means of financing a project is attractive because the tax
deductibility of the debt payments protects some income from taxes.
Financial Flexibility
This is essentially the firm's ability to raise capital in bad times. It should come
as no surprise that companies typically have no problem raising capital when
sales are growing and earnings are strong. However, given a company's strong
cash flow in the good times, raising capital is not as hard. Companies should
make an effort to be prudent when raising capital in the good times, not
stretching its capabilities too far. The lower a company's debt level, the more
financial flexibility a company has.

Determinats of Capital Structure

Decisions

Management Style
Management styles range from aggressive to conservative. The more conservative a
management's approach is, the less inclined it is to use debt to increase profits. An
aggressive management may try to grow the firm quickly, using significant amounts of
debt to ramp up the growth of the company's earnings per share (EPS).
Growth Rate
Firms that are in the growth stage of their cycle typically finance that growth through
debt, borrowing money to grow faster. The conflict that arises with this method is that the
revenues of growth firms are typically unstable and unproven. As such, a high debt load
is usually not appropriate.
Market Conditions
Market conditions can have a significant impact on a company's capital-structure
condition. Suppose a firm needs to borrow funds for a new plant. If the market is
struggling, meaning investors are limiting companies' access to capital because of market
concerns, the interest rate to borrow may be higher than a company would want to pay. In
that situation, it may be prudent for a company to wait until market conditions return to a
more normal state before the company tries to access funds for the plant.

HOW TO ESTIMATE TARGET CAPITAL

STRUCTURE
EBIT-EPS

ANALYSIS

ROE-ROI

ANALYSIS

EBIT-EPS ANALYSIS

It helps to understand what should be the optimum

capital structure which could generate highest EPS. It
would help in determining what should be the direct
ideal combination of debt-equity capital structure.

It can be well explain with the help of break-even

point (indifference point).It refers to the EBIT level
at which the EPS remains same for two different
financial plans.

EBIT-EPS ANALYSIS

At break even point we can calculate the EBIT & EPS by

using the formula
(EBIT-I)(1-t)
N

(EBIT-I)(1-t)
N

ROE-ROI ANALYSIS
E.g. Korex limited which requires an investment outlays of Rs
100 million is considering two capital structures

While the average cost of debt is 12%,the ROI may vary

widely & tax rate is 50%

MATHEMATICALLY CALCULATED AS FOLLOW

THANK YOU