Professional Documents
Culture Documents
Trading
On equity or
Financial
leverage
Cost of
control
financing
Statutory Period of
requirements financing
Financial structure and capital structure
Traditional approach
ASSUMPTIONS:-
ONLY TWO TYPES OF CAPITAL EMPLOYED:-- DEBT AND EQUITY
TOTAL ASSETS REMAIN THE SAME
NO RETAINED EARNINGS
PERPETUAL LIFE
FIRM’S OPERATIVE EARNINGS ( EBIT) REMAINS CONSTANT
FIRMS’ BUSINESS RISK REMAINS THE SAME
TOTAL FINANCING OF THE FIRM REMAINS THE SAME
NO TAX
RELATIONSHIP
CAPITAL
STRUCTURE
COST OF
CAPITAL
VALUE OF
THE FIRM
Net income approach
Net operating income approach
Traditional approach
Modigliani miller approach
V = EBIT / Kw
– EBIT 200000
– Kw 10%
– Mkt value of the company 200,000/10% = 20,00,000
– Total value of debt 500,000
– Market value of equity 15,00,000
– Ke = EBIT – I / D * 100 = 10.67%
If the company increases the debt content by
decreasing the equity content, the total value
of the company would remain unchanged but
the capitalization rate will increase.
TRADITIONAL APPROACH
The cut off rate for investment is always independent of the way
in which an investment is financed.
Criticism of MM hypothesis
Questions :-
What do you understand by capital structure of a
firm?
Explain the approaches in capital structure
Cost of capital
SIGNIFICANCES:-
– Device an optimum capital structure
– Serve as a discount rate for selecting projects.
MEANING
IS A HURDLE RATE
STRUCTURE
Significance of cost of capital
COST OF DEBT:-
– RATE OF RETURN EXPECTED BY THE LENDERS
– INTEREST RATE SPECIFIED AT THE TIME OF ISSUE
– ISSUED AT PAR,PREMIUM OR DISCOUNT
– ISSUED AT PAR:-
– Kd = R( 1- T)
– T= tax rate
– R= interest rate = annual interest / net proceeds * 100
A company issues 10% debentures for 100,000.
rate of tax 50%. Calculate the cost of debt (after
tax) when issued at PAR ,10% PREMIUM AND 10%
DISCOUNT
At discount:- 5.6%
COST OF PREFERENCE SHARE CAPITAL
Kp = Dd / P
CONTROL OF THE COMPANY ISSUE
Kp= cost Of PS
10000/110000
10000/90000
COST OF EQUITY SHARES
D/P + G