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 firms 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

Operating leverage Management attitudes Cash flow stability Corporate tax rate Purpose of financing Legal requirements Capital market conditions Control

Period of finance
Nature and size of the firm Asset structure Growth and stability of sales Debt covenants Flexibility

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 dont 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 didnt pose much a problem. We dont 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 terms for supporting 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!!