CAPITAL STRUCTURE:

MEANING:

- Capital structure of a firm is a reflection of the overall investment and

financing strategy of the firm.

- Capital structure can be of various kinds as described below:

 Horizontal capital structure: the firm has zero debt component

in the structure mix. Expansion of the firm takes through equity
or retained earnings only.

 Vertical capital structure: the base of the structure is formed by

a small amount of equity share capital. This base serves as the
foundation on which the super structure of preference share
capital and debt is built.

 Pyramid shaped capital structure: this has a large proportion

consisting of equity capita; and retained earnings.

 Inverted pyramid shaped capital structure: this has a small

component of equity capital, reasonable level of retained
earnings but an ever-increasing component of debt.

SIGNIFICANCE OF CAPITAL STRUCTURE:

- Reflects the firm’s strategy

- Indicator of the risk profile of the firm
- Acts as a tax management tool
- Helps to brighten the image of the firm.

FACTORS INFLUENCING CAPITAL STRUCTURE:

- Corporate strategy
- Nature of the industry
- Current and past capital structure
CAPITAL STR. V/S FINANCIAL STR.:

1. CS relates to long-term capital deployment for creation of long-term assets. FS

involves creation both long term and short term assets.

2. CS is the core element of the financial structure. CS can exist without the current
liabilities and in such cases; CS shall be equal to the financial structure.

3. FS of a firm is considered to be a balanced one if the amount of current liabilities

is less than the capital structure net outside debt because in such cases the long-
term capital is considered sufficient to pay current liabilities in case of sudden
loss of current assets.

4. Components of the CS may be used to build up the level of current assets but the
current liabilities should not be used to finance acquisition of fixed assets.

PLANNING AND DESIGNING OF CAPITAL STRUCTURE:

- Attributes of a well planned capital structure

- Designing a capital structure
- Design should be functional
- Design should be flexible
- Design should be confirming statutory guidelines

DETERMINANTS OF CAPITAL STRUCTURE:

- Minimization of risk
- Maximization of profit
- Nature of the project
- Control of the firm

COST OF CAPITAL:

Factors determining cost of capital:

- General economic conditions: fluctuations in interest rates occur as a result

of changes in the demand supply equilibrium of ingestible funds.

- Risk profile of the project: a project considered risky would attract capital at
a higher cost than a project in the same industry having lesser risk.

COST OF DEBT:

- Concerned essentially with the long-term debt of the firm.

- The long-term debt has been used to finance long-term projects.
 - We denote cost of debt by the symbol k (d). It is calculated in different ways
depending upon whether the debt is a rolling or a term debt redeemable at the
expiry of the term.

COST OF PREFERENCE SHARE CAPITAL:

- The preference dividend is akin to the interest payment and redemption of

preference capital is equivalent to redemption of debt.

- Its inclusion in the share capital component is primarily done to bring down
the borrowings of the firm in the balance sheet.

- Cost of preference share capital is arrived at by equating the aggregate of

present value of the periodic dividend payments and the redemption amount.