CAPITAL STRUCTURE

DECISIONS IN FINANCIAL
MANAGEMENT
AFTERSCHO☺OL
– DEVELOPING CHANGE MAKERS
CENTRE FOR SOCIAL ENTREPRENEURSHIP
PGPSE PROGRAMME –
World’s Most Comprehensive programmes in social
entrepreneurship & spiritual entrepreneurship
OPEN FOR ALL FREE FOR ALL

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 CAPITAL STRUCTURE
DECISIONS IN FINANCIAL
MANAGEMENT
Dr. T.K. Jain.
AFTERSCHO☺OL
Centre for social entrepreneurship
Bikaner M: 9414430763
tkjainbkn@yahoo.co.in
www.afterschool.tk, www.afterschoool.tk
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 What is capital structure?
• Combination of capital is called capital
structure. The firm may use only equity, or
only debt, or a combination of equity +
debt, or a combination of
equity+debt+preference shares or may
use other similar combinations.

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 How do you design capital
structure?
1. It should minimise cost of capital
2. It should reduce risks
3. It should give required flexibility
4. It should provide required control to the
owners
5. It should enable the company to have
adequate finance.

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 What are the risks associated with
capital structure decisions?
• Meaning of risk = variability in income is
called risk.
• Business risk = it is the situation, when the
EBIT may vary due to change in capital
structure. It is influenced by the ratio of fixed
cost in total cost. If the ratio of fixed cost is
higher, business risk is higher.
• Financial risk = it is the variability in EPS due
to change in capital structure. It is caused
due to leverage. If leverage is more,
variability will be more and thus financial risk
will be more.
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 Degree of financial leverage?
• It shows the extend of financial risk.
Higher the DFL, higher is the financial risk.
• Formula =
• % change in EPS / % change in EBIT.
• Suppose EBIT changes 10%, due to this
EPS changes 20%,
• 20/10 = 2
• DFL is 2.
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 EBIT - EPS analysis
• Generally cost of debt is lower than cost of
equity. Therefore raising debt (trading on
equity) increases EPS and it gives benefit
to the shareholders. However, excess of
debt will create more risk and therefore it
is not advisable. A firm can identify an
ideal level of quantum of debt and equity
so that it is within proportion.

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 Formula
• [(EBIT – I1) (1-t)]/ E1 = [(EBIT – I2) (1-t)]/
E2
• E1 = equity in 1st alternative (no debt or
minimum debt)
• E2 = equity in 2nd alternative (no debt or
max. debt)
• I1 and I2 represent interest payable in the
2 alternatives respectively.
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 What do you understand from
trading on equity?
• With capital, we can raise debt, and raise
our EPS, this is called trading on equity.

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 What is coverage ratio or DSCR?
• DSCR = debt service coverage ratio
• Coverage ratio denotes the extent to which
interest is covered by the EBIT. It denotes
whether we have sufficient earnings to meet
our interest obligation. If DSCR is 1 or less
than one, it is dangerous situation.
• Formula = EBIT / interest.
• Higher the DSCR, less is the risk (because
there is higher coverage).

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Theory of optimal capital structure?
• This theory states that we can have an
optimum capital structure – as we raise the
debt, we can raise the value of the firm to
some extent. Thus level of debt can be
increased upto some level. That level is the
ideal capital structure.
• Ultimate objective of Finance manager is to
raise the value of the firm and raise the
wealth – which is possible by an ideal capital
structure.
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 Is there indifference point?

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 Solve the following
• Goti continental Inc. a profit makipg company, has a paid-
up capital of Rs. 100 lakhs consisting of 10 lakhs ordinary
shares of Rs. 10 each. Currently, it is earning an annual
pre-tax profit of Rs. 60 lakhs. The company’s shares are
listed and are quoted in the range of Rs. 50 to Rs. 80. The
management wants to diversify production and has
approved a project which will cost Rs. 50 lakhs and which
is expected to yield a pre-tax income of Rs. 40 lakhs per
annum. To raise this additional capital, the following
options are under consideration of the management:
• (a) To issue equity capital for the entire additional
amount. It is expected that the new shares (face value of
Rs. 10) can be sold at a premium of Rs. 15.
• (b) To issue 16% non-convertible debentures of Rs. 100
each for the entire amount. Tax rate = 30%

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 Solution
• (a) raising additional equity – how much
equity required?
• One share will give you 10 + 15 = 25
• Capital required = 50 lakhs.
• 50/25 = 2 lakh shares. (we already have
10 lakh shares)

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 Solution
• (a) All equity : • (B) All debt
• Earnings = 60 + 40 = 100 • Earnings = 60 + 40 = 100
• Tax: 30 • Payment of interest:
• EAT = 70 • 16% of Rs. 50 lakhs =8
• No. of shareholders: 12 lakhs
lakh shares • EAIBT = 92
• EPS = 70 / 12=5.83 • Tax: 30% = 27.6
• EAT = 64.4
• No. of shareholders: 10
lakh shares
• EPS = 64.4 / 10=6.44

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 Analysis
• From the above analysis, it is clear that
EPS is higher in the case when we are
raising debt. (therefore this option is better
and the firm should go for raising debt).
• We also have to look at the overall market
capitalisation and overall value of the firm.
• Suppose, PE ratio of the industry is 20,
the value of the firm is as under:
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 Solution
• (a) all equity
• 5.83 *20 = 116.6
• Multiply it with 12 lakhs,
• extent as Beta will
The value of the firm is
1399.2 lakhs. Thus from
this analysis, this option
is better.
• Debt
• Use of debt will reduce
the PE ratio to some
increase. However, let us
calculate using 20 as PE
ratio:
• 20*6.44 = 128.8 *10
lakhs + 16 lakhs
• =1304 lakhs

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 Theories of capital structures . .
• There are 4 theories:
2. NI approach (net income approach)
3. NOI approach (net operating income
approach)
4. MM approach (Modigliani Millar
Approach)
5. Traditional approach

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 Assumptions in capital structure
theories …..
1. There are only 2 sources of finance –
debt and equity
2. Taxes are ignored
3. Dividend payout ratio is 100%
4. Business risk is constant
5. Firm’s total financing remains constant.

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NI approach (net income approach)
• When you raise debt, leverage will increase. The
overall value of the firm will incrase. Debt will
have lower cost, so overall cost of capital will
reduce (it is better if the cost of capital reduces).
• V = S+ D
• V = value of the firm, S = equity, D = debt
• An increase in leverage will increase the value of
the firm, it will raise EPS, it will raise the market
price of the shares and it will reduce weighted
average cost of capital, thus leverage is always
beneficial.

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 NOI approach (Net operating
income approach)
• Capital structure decision is irrelevant. If
you raise debt, the cost of equity will
increase. The overall cost of capital will
remain constant in spite of leverage. Thus
there is no advantage of raising debt. As
we raise the debt, the cost of equity
increases in the same proportion. The
market discounts the firm, which is
leveraged. Thus capital structure decision
has no relevance.
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 MM approach
• It is similar to NOI approch

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 Traditional approach
• It says that with the use of debt, the
overall cost of capital comes down upto
some extent and thereafer the overall cost
of capital increases. Thus there is an ideal
point, upto which the overall cost of capital
will decrease with the help of increase in
debt, beyond which the use of debt is
detrimental to the company.

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 ABOUT AFTERSCHO☺OL
Afterschoool conducts three year integrated PGPSE
(after class 12th along with IAS / CA / CS) and 18
month PGPSE (Post Graduate Programme in Social
Entrepreneurship) along with preparation for CS / CFP /
CFA /CMA / FRM. This course is also available online
also. It also conducts workshops on social
entrepreneurship in schools and colleges all over India –
start social entrepreneurship club in your institution
today with the help from afterschoool and help us in
developing society.

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 Why such a programme?
• To promote people to take up entrepreneurship
and help develop the society
• To enable people to take up franchising and
other such options to start a business / social
development project
• To enable people to take up social development
as their mission
• To enable people to promote spirituality and
positive thinking in the world

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 Who are our supporters?
• Afterschoolians, our past beneficiaries,
entrepreneurs and social entrepreneurs
are supporting us.
• You can also support us – not necessarily
by money – but by being promotor of our
concept and our ideas.

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 About AFTERSCHO☺OL PGPSE – the
best programme for developing great
entrepreneurs
• Most flexible, adaptive but rigorous programme
• Available in distance learning mode
• Case study focused- latest cases
• Industry oriented practical curriculum
• Designed to make you entrepreneurs – not just
an employee
• Option to take up part time job – so earn while
you learn
• The only absolutely free course on internet
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 Workshops from
AFTERSCHO☺OL
• IIF, Delhi
• CIPS, Jaipur
• ICSI Hyderabad Branch
• Gyan Vihar, Jaipur
• Apex Institute of Management, Jaipur
• Aravali Institute of Management, Jodhpur
• Xavier Institute of Management, Bhubaneshwar
• Pacific Institute, Udaipur
• Engineering College, Hyderabad

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 Flexible Specialisations:
• Spiritualising business and society
• Rural development and transformation
• HRD and Education, Social Development
• NGO and voluntary work
• Investment analysis,microfinance and inclusion
• Retail sector, BPO, KPO
• Accounting & Information system (with CA / CS /CMA)
• Hospital management and Health care
• Hospitality sector and culture and heritage
• Other sectors of high growth, high technology and social
relevance

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 Salient features:
• The only programme of its kind (in the whole world)
• No publicity and low profile course
• For those who want to achieve success in life – not just a
degree
• Flexible – you may stay for a month and continue the rest of
the education by distance mode. / you may attend weekend
classes
• Scholarships for those from poor economic background
• Latest and constantly changing curriculum – keeping pace
with the time
• Placement for those who are interested
• Admissions open throughout the year
• Latest and most advanced technologies, books and study
material

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 Components
• Pedagogy curriculum and approach based on IIM Ahmedabad and ISB
Hyderabad (the founder is alumnus from IIMA & ISB Hyderabad)
• Meditation, spiritualisation, and self development
• EsGotitial softwares for business
• Business plan, Research projects
• Participation in conferences / seminars
• Workshops on leadership, team building etc.
• Written submissions of research projects/articles / papers
• Interview of entrepreneurs, writing biographies of entrepreneurs
• Editing of journals / newsletters
• Consultancy / research projects
• Assignments, communication skill workshops
• Participation in conferences and seminars
• Group discussions, mock interviews, self development diaryng
• Mind Power Training & writing workshop (by Dr. T.K.Jain)

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 Pedagogy
• Case analysis,
• Articles from Harvard Business Review
• Quiz, seminars, workshops, games,
• Visits to entrepreneurs and industrial visits
• PreGotitations, Latest audio-visuals
• Group discussions and group projects
• Periodic self assessment
• Mentoring and counselling
• Study exchange programme (with institutions out of
India)
• Rural development / Social welfare projects
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 Branches
• AFTERSCHO☺OL will shortly open its
branches in important cities in India
including Delhi, Kota, Mumbai, Gurgaon
and other important cities.
Afterschooolians will be responsible for
managing and developing these branches
– and for promoting social entrepreneurs.

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 Case Studies
• We want to write case studies on social
entrepreneurs, first generation
entrepreneurs, ethical entrepreneurs.
Please help us in this process. Help us to
be in touch with entrepreneurs, so that we
may develop entrepreneurs.

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Basic values at AFTERSCHO☺OL
• Share to learn more
• Interact to develop yourself
• Fear is your worst enemy
• Make mistakes to learn
• Study & discuss in a group
• Criticism is the healthy route to mutual support
and help
• Ask fundamental questions : why, when, how &
where?
• Embrace change – and compete with yourself
only
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 www.afterschoool.tk
social entrepreneurship for better
society

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