DEPT. OF BUS. ADM.

& MANAGEMENT
SGBAU, AMRAVATI.

Presentation on:
CAPITAL STRUCTURE
By- Gaurav Koshti.
What is Capital Structure

Capital Structure means the structure or

constitution of capital employed by a firm. The
capital employed consist of both the owners capital
& the debt capital provided by the lenders. Debt
capital is understood here to mean the long term
debt which has been deployed to build long term
assets.

Capital Structure of a firm is a reflection of overall

investment and financing strategy of the firm.
 Types of Capital Structure

Horizontal Capital Structure

Vertical Capital Structure

Pyramid Shaped Capital Structure

Inverted Pyramid Capital Structure

Significance of Capital Structure

Reflects the firm’s strategy

Indicator of the risk profile of the firm

Act as a tax management tool

Helps to brighten the image of the firm

 Optimal Capital Structure

A firm should select such a financing mix as will maximize the shareholders wealth, such a
capital structure is referred to as a optimum capital structure

It means a particular arrangement of various components of the structure for both short as
well as long term objectives of the firm.

It means increases the Earning Per Share(EPS) at maximum level.

For designing such a structure, one would need
following information.

The requirement of capital of the firm

Availability of the firm

Cost of these components

Rate of interest from investment

C ontd.
 Determinants of Capital
Structure
Minimization of risk

Maximization of profit

Nature of the project

Control of the firm

Capital Structure Theories

There are basically four approaches to capital

structure decision.

Net Income Approach

Net Operating Income Approach

Modigliani-Miller Approach

Traditional Approach
Net Income Approach

Capital structure decision is relevant to the

valuation of the firm, i.e. a change in the
financial leverage will lead to a corresponding
change in the overall cost of capital as well as
total value of the firm. If, therefore, degree of
leverage as measured by debt-equity ratio
increase, the weighted avg. cost of capital will
decline, while value of firm as well as market
price of share will increase.
Net Income Approach
EBIT 50000
 I Int. on debt.(10%) - 10000 (100000 Debt)
EBT ( Net Income) 40000
ke = (12.5% Equity share) 40000/12.5%
320000 (equity share)
Value of firm=S+B
= 320000+100000
V = 420000
There are certain assumptions in net income
approach.
Net Operating Approach

Capital structure decision of a firm is

irrelevant to any change in financial
leverage & will not lead to any change in
total value of the firm & the market price
of share as well as overall cost of capital is
independent of the degree of leverage.
Net Operating Approach
EBIT (Net Income App.) 50000
 Nil - Nil
EBT 50000
Cost of Capital(Ko) is 10%
V= EBIT Value of firm= 50000
Ko 10%
= 500000
S= V-B (500000-100000) = 400000
Vu= S
Modigliani-Miller Approach

The MM approach supports the NOI

approach relating to independence of the
cost of capital for any degree of leverage at
any level of debt-equity ratio. The MM
approach provides behavioral justification
for constant overall cost of capital &
therefore total value of the firm.
Modigliani-Miller Approach
A co(L) B Co(U)

 EBIT 200000 200000

- I (400000,10%) 40000 -
EBT 160000 200000
- T (Tax 40%) 64000 64000
EAT 96000 136000
Ke15%
Traditional Approach

It includes some features of NI & NOI. It

resembles the NI approach in arguing that
the total value of the firm & cost of capital
are related to capital structure, with NOI
approach, the overall cost of capital
remains constant only for certain degree of
leverage beyond that certain degree Ko
increases & v decreases.
THANK YOU