Dinesh Chaure 47

Definition Capital Structure Consists Of Owned Funds Borrowed Funds Factors Influencing Capital Structure Internal Factors External Factors Assumptions Theories of Capital Structure Net Income (NI) Theory Net Operating Income (NOI) Theory Traditional Theory Modigliani-Miller (M-M) Theory Format Of Evaluation Of Alternative Capital Plans

A Firm has the choice to raise funds for financing its projects with the following choices: (a)Only with equity shares. (b)With equity & preference shares. (c)With equity shares & debentures. (d) With equity, preference shares & debentures.

Internal Factors

External Factors

Size of Business Nature of Business Cost of capital Risk Factor Control factor Operating Ratio

General Economic Conditions Nature of Investors Level Of Interest rates Taxation Policy Policies of Financial Institutions Cost of Financing Seasonal Variations Economic Fluctuations Nature of Competition

There are only two source of funds. There are no corporate taxes. The dividend-payout ratio is 100. The total assets remain constant. Firms total financing remain constant. Risk perception of the investor remains constant. The operating profit (EBIT) are not expected to grow. Perpetual life of the firm. Return on Investment remains constant. Investors profits remains constant.

 Net Net

Income (NI) Theory

Operating Income (NOI) Theory

Traditional

Theory
(M-M) Theory

Modigliani-Miller

Firm has a perpetual life. Corporate income tax does not exist.

Company follows a 100 % dividend pay out policy. Operating income of company not to grow over time.

Effect of inducing more debt

If however, the amount of debt is increased further, two things are likely to happen: 1)The investment in the firm would become very risky to the creditors 2)the expectations of investors in terms of returns on their investment may increase & share price of the company may decrease.

Optimum Capital Structure

Another variant of the traditional approach suggests that there is no one single capital structure,but,there is a range of capital structures in which the cost of capital(Ko) is the minimum and the value of the firm is the maximum. In this range, changes in leverage have very little effect on the value of the firm.