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GROUP PROFILE
GROUP #15
Serial No.
01. 02. 03. 04.
05.

Name

ID

Sumaiya Amena

15-051

Capital structure

oThe

mix of debt, preferred stock and common equity with which the firm plans to finance its investment.
oThe

optimal capital structure is the one that strikes a balance between risk and return to achieve the ultimate goal of maximizing the price of the stock.

Debt Using more debt generally increases the risk associated with future earnings Debt has a fixed cost (that is, interest), so more debt allows the firm to earn a higher expected rate of return. Equity Less risky to financial operations than debt, because there is no contractual obligation to pay dividends Higher cost, because stock is a riskier investment for investors Optimal capital structure is where the value of the firm is maximized because the overall WACC, or r, is minimized.

Capital structure

Capital StructureTrade-Off Theory

The

value of a firm increases as it uses more and more debt. Ignores the costs associated with bankruptcy, which can be considerable If bankruptcy costs are considered, there is a point where the benefit of the tax deductibility of debt is more than offset by increases in the cost of debt and the cost of equity that result from the risk associated with the firms heavy use of debt

ANALYSIS ON OPTIMAL CAPITAL STRUCTURE

The leverage effect-

EXAMPLE (1): CONSTANT DEBT-EQUITY RATIO (D = E):

Deployed capital can, affected by an unfavorable (ROC = 2%), average (ROC = 6%), or favorable (ROC = 14%) market development with equal probability, earn three different returns. with a debt-equity ratio of 1 (D = E) and an interest rate on debt of i = 6%, the leverage equation gives the following returns on equity:

EXAMPLE (2): DIFFERENT DEBT LEVELS:

THE TRADITIONAL APPROACH:

Shows

the dependence of the required return on equity on the level of debt.

Minimizing

WACC equals maximizing overall firm

value.

COMPARISON OF THEORIES

THE TRADE-OFF BETWEEN PROFITABILITY AND RISK OF NAVANA CNG LTD.

If

NAVANA CNG Ltd. decides to use debt, the firm will be faced with a trade-off between the following:

Debt

can be issued to increase NAVANA CNG Ltd.s expected EPS, but then NAVANA CNG Ltd.s shareholders will have to take more risk Stay all-equity financed, but then NAVANA CNG Ltd.s shareholders will end up with lower expected EPS
To

find out what to do, we need to determine how debt financing affects the firms value, not just EPS

EFFECT OF CHANGES IN CAPITAL STRUCTURE ON THE FIRMS COST OF CAPITAL:

If the firm were debt-free Its cost of capital is equal to the expected return on its assets

As the firm decides to replace some equity with debt

The claims on the firms return on assets will be proportional to the shareholders and debt holders contributions

STRUCTURE OF LONG- TERM DEBT FINANCING:

Debentures. 68,000,000 Lease finance liabilities94,238,530 Long term bank borrowings nil Total long term debt. 162,238,530 Total short term debt . 155,256,799 Total debt .... 317,495,329

STRUCTURE OF SHAREHOLDERS EQUITY:

Share capital: 5,100,000 ordinary shares of Tk. 10 each issued in cash.. 51,000,000 31,200,000 ordinary shares of Tk. 10 each issued bonus share 312,000,000 Total Share capital ................... 363,00,000 Tax Holiday Reserve. 180,618,848 Retained Earnings.. 374,332,855 Shareholders Equity... 917,951,703

THE DEBT TO EQUITY RATIO:

Debt to Equity Ratio = = 25.70% = 26%. (Approximately) Return on Equity (ROE): ROE= (Net income / Share holders equity) = (290,789,036 917,951,703) = 0.316789 = 31.70%. (Approximately) Return on Asset (ROA): ROE = (Net income / Total assets) = (290,789,036 1235, 447,032) = 23.55 %.( Approximately).