FINANCIAL MANAGEMENT

CAPITAL STRUCTURE

Presented by
HariKrishnan R
(10AC12)
 Introduction
• Capital Structure is the proportion of debt,
equity share and preference shares on a firm’s
balance sheet.
• Raising of capital from different sources and
their use in different assets by a company is
made on the basis of certain principles that
provide a system of capital so that the
maximum rate of return can be earned at a
minimum cost.
 Factors Influencing Capital Structure
Internal Factors
• Size of Business
• Nature of Business
• Regularity and Certainty
of Income
• Assets Structure
• Future Plans
• Operating Ratio
• Period and Purpose of
Financing
External Factors
• Capital Market
Conditions
• Nature of Investors
• Taxation Policy
• Policies of Financial
Institutions
• Cost of Financing
• Economic Fluctuations
• Nature of Competition
 Optimal Capital Structure
• It is the combination of debt and equity which
maximizes the value of the company and
minimizes the cost of capital.
• The optimal or the best capital structure
implies the most economical and safe ratio
between various types of securities.
Essentials of a Optimal Capital Structure
• Minimum Cost of Capital
• Minimum Risk
• Maximum Return
• Maximum Control
• Safety
• Simplicity
• Flexibility
• Attractive Rules
 Basic Ratio
Optimal Capital Structure requires
• Debt Equity Ratio 1:1
• Current Ratio 2:1 and Liquidity Ratio 1:1
• Total Debt Capital should not exceed 50% of the
depreciated value of assets
• Total Long term loans should not be more than net
working capital
 Capital Structure Theories
Assumption :
• Only 2 sources of funds used by a firm –
Riskless debt and ordinary shares
• Dividend payout ratio is 100
• Operating profits are not expected to grow
• Business risk is constant over time
 Net Income (NI) Theory
• According to this theory a firm can increase the value
of the firm and reduce the overall cost of capital by
increasing the proportion of debt in its capital
structure to the maximum possible extent
• It is due to the fact that debt is, generally a cheaper
source of funds because:
– Interest rates are lower than dividend rates due to
element of risk
– The benefit of tax as the interest is deductible
expense for income tax purpose.
Net Operating Income(NOI) Theory
• According to this theory, the total market
value of the firm (V) is not affected by the
change in the capital structure and the overall
cost of capital (Ko) remains fixed irrespective
of the debt-equity mix.
 Modigliani-Miller(MM) Theory
• MM propositions supports NOI approach
relating to the independence of the cost of
capital of the degree of leverage at any level
of debt-equity ratio
• MM approach maintains the WACC does not
change with change in the proportion of debt
to equity in the capital structure.
 Capital structure of Lavasa corporation
Limited

• Total Capital = Rs. 231930.45 Lakhs

• Debt-Equity Ratio = 3.268

• Debt-Asset Ratio = 1.138

• Degree of Financial Leverage = 1.866