Capital Structure Theories

Presented by:
Nidhi Agarwal 01
Rinku Chauhan 07
Vaibhav Janvalkar 17
Darshan Joshi 18
Akshit Karia 21
 Capital Structure
“Capital Structure of a company
refers to the composition or make-up of its
capitalization and it includes all long-term
capital resources, viz. loans, reserves,
shares and bonds”.

----Gestenberg
CAPITAL STRUCTURE
THEORIES

2. Net Income Approach

3. Traditional Approach

5. NetOperating Income Approach

6. Modigliani And Miller Approach
CAPITAL STRUCTURE
THEORIES

2. Net Income Approach 1.Cost of debt is less

than cost of equity
3. Traditional Approach

3.There are no taxes

5. Net Operating Income Approach
5.The risk perception
6. Modigliani And Miller Approach
of investors is not
changed by the use
of debt
CAPITAL STRUCTURE
THEORIES

2. Net Income Approach 1.Cost of debt remain

less constant but
3. Traditional Approach
after certain limit it
start increasing.
2.Similarly cost of
5. Net Operating Income Approach
equity also remain
6. Modigliani And Miller Approach
less constant and
increase after
certain limit
3.Total cost of capital
decrease up to
certain point, then
CAPITAL STRUCTURE
THEORIES

2. Net Income Approach 1.Cost of Capital and

cost of debt remain
3. Traditional Approach
constant.

5. Net 3.Cost
Operating Income Approach of equity
increase
6. Modigliani And Miller Approach with
increase in
leverage.
CAPITAL STRUCTURE
THEORIES

2. Net Income Approach 1.There is a perfect

market.
3. Traditional Approach

3.Investors act
rationally.
5. Net Operating Income Approach
6. Modigliani And Miller Approach
5.Rational investors
and manager

7.Homogeneous
expectation
TVS MOTORS COMPANY
TVS Motors Company

 TVS Motor Company is the third largest two-wheeler

manufacturer in India and one among the top ten in the
world, with annual turnover of more than USD 1 billion
in 2007-2008, and is the flagship company of the USD 4
billion TVS Group.
 TVS has always stood for innovative, easy to handle,
environment friendly products, backed by reliable
customer service.
 Mission- “We are committed to being a highly profitable,
socially responsible, and leading manufacturer of high
value for money, environmentally friendly”.
 There network spans 48 countries all over the world.
TVS Motors

Particulars 2007-08 (in crores) 2008-09(in crores)

OPERATING INCOME 45.31 121.08

INTEREST ON DEBT( I) 11.47 64.61
EQUITY EARNING 33.84 56.47
COST OF EQUITY (Ke) 4.13% 4.21%
MARKET VALUE OF 819.37 1341.33
EQUITY
COST OF DEBT (Kd) 1.72% 7.13%
MARKET VALUE OF 666.34 905.98
DEBT
VALUE OF FIRM 1485.71 2247.31
COST OF CAPITAL (Ko) 3.05% 5.39%
WACC 2007-08

 WACC= weke + wdkd

 We = E/(D+E)
 Wd = D/(D+E)
= 1/(1.84) x 0.413 + 0.84/(1.84) x 0.172
= 0.2284 +0.078
= 3.051%
WACC 2008-09

 WACC= weke + wdkd

 We = E/(D+E)
 Wd = D/(D+E)
= 1/(2.11) x 4.21 + 1.11/(2.11) x 7.13
=1.995 +3.750
= 5.75%
 Theory V/S Observation

 Ke remains constant  Ke has increased with the increase in

the market value of the firm hence we
can infer that there are many different
factors which affects the market value
of the firm say as confidence of the
share holder.

 Kd remains constant  Kd has drastically increased with the

increase in the Market value of the
debt. It is only due to company has
raised debt from external sources for
its operations.
Theory V/S Observation

 With the increase  With the increase

in D/E ratio the in D/E ratio the
wacc will decline, WACC has also
while the value of increased with the
the firm increases increase in the
whereas MPS value of the firm
decreases. while the decrease
in MPS this is
because negative
attitude of share
holder towards
the company.
 Cont…

 As per the annual report company has raised its

debt fund and invested in purchasing assets for the
co. may b for the future prospects but at the same
time due to the high leverage and risk,
shareholders are expecting higher returns which
the co. is not able to meet currently. Hence, giving
the adverse effect to MPS.

 As per the annual report published the DPS

declared is same for both the years of Rs.0.70 per
share. This clarifies that the co. is trying to
preserve the funds or to invest the profit earned
into the vital areas.
HERO HONDA
HERO HONDA COMPANY

 Hero Honda is a world leader because of its excellent manpower,

proven management, extensive dealer network, efficient supply chain
and world-class products with cutting edge technology.
 During the 80s, Hero Honda became the first company in India to
prove that it was possible to drive a vehicle without polluting the
roads.
 Over 20 million Hero Honda two wheelers tread Indian roads today.
 Hero Honda’s mission is to strive for synergy between technology,
systems and human resources, to produce products and services that
meet the quality, performance and price aspirations of its customers.
At the same time maintain the highest standards of ethics and social
responsibilities.
Hero Honda

Particulars 2007-08 (in crores) 2008-09(in crores)

OPERATING INCOME 1201.96 1367.77

INTEREST ON DEBT( I) 13.76 13.47
EQUITY EARNING 1188.22 1354.3
COST OF EQUITY (Ke) 34.73% 32.41%
MARKET VALUE OF 3421.25 4178.65
EQUITY
COST OF DEBT (Kd) 8.33% 10.20%
MARKET VALUE OF 165.18 132.05
DEBT
VALUE OF FIRM 3586.43 4310.70
COST OF CAPITAL (Ko) 33.51% 31.73%
WACC 2007-08

 WACC= weke + wdkd

 We = E/(D+E)
 Wd = D/(D+E)
= 1/(1.07)x34.73%+0.07/(1.07) x 8.33%
= 33%
WACC 2008-09

 WACC= weke + wdkd

 We = E/(D+E)
 Wd = D/(D+E)
= 1/(1.04)x32.41%+1.04/(1.04)x10.20%
= 31.55%
 Theory V/S Observation

 Ke remains constant  Ke has decreased with the increase in

the market value of the firm hence we
can infer that there are many different
factors which affects the market value
of the firm say as confidence of the
share holder.

 Kd remains constant  Kd has increased with the decrease in

the Market value of the debt but there
is a marginal reduction in the amount
of interest so due to that Kd increases.
Theory v/s observation

 With the increase  With the decrease

in leverage, cost in leverage, cost
of capital of capital is also
decreases and decreasing.
vice- versa.
 Effects of interest rates on hero honda.

 Management outlook towards

operating margin.
CONCLUSION
 Thank you