CAPTIAL STRUCTURE

When funds are required for the Company ? What happen if funds are short or More ? What is essential for having adequate and sufficient funds ? Correct estimation of the current and future capital needs of the Company Is it possible to have a optimal capital structure in reality?

Point of difference
Refers

Capitalisatio Capital n Structure

Qualitative Total amount of securities issued

Financial Structure
Qualitative

Aspect of quantitative financial planning

Proportion of Proportion of long long term term and short securities issued term securities issued
Determination of Determination of Proportion of long both long term and term sources short term sources Broad Broad

Objective

Determination of total amount of capital Narrow

Concept

Compute Capitalisation Capital Structure Financial Structure

From the given information:

Liabilities Equity Share Capital Preference share Capital Long Term Loans and Debentures Retained Earnings Capital Surplus Current Liabilities Rs 10,00,000 5,00,000 2,00,00 6,00,000 50,000 1,50,000 25,00,000

1. Capitalization refers to the total amount of securities issued by a company.

Sources Equity Share Capital Preference share Capital Long Term Loans and Debentures Total Rs Rs 10,00,000 5,00,000 2,00,00 17,00,000

2. a.Capital Structure : Proportionate amount that makes up capitalization .

Sources Equity Share Capital Preference share Capital Long Term Loans and Debentures Total Rs

Rs 10,00,000 5,00,000 2,00,00 17,00,000

Proportion/Mi x 58.82 % 29.41% 11.77% 100%

2.b.Some authors include retained earnings and capital surplus also for the purpose of capital structure: In that case Capital Structure
Sources Equity Share Capital Preference share Capital Long Term Loans and Debentures Retained Earnings Capital Surplus Total Rs Rs 10,00,000 5,00,000 2,00,00 6,00,000 50,000 23,50,000 Proportion/Mix 42.55 % 21.281% 8.51% 25.53% 2.13% 100%

3. Financial Structure refers to the financial resources, short as

well as long- term Structure:
Rs Equity Share Capital Preference share Capital Long Term Loans and Debentures Retained Earnings Capital Surplus Current Liabilities Total Rs 10,00,000 5,00,000 2,00,00 6,00,000 Sources 1,50,000 25,00,000 100% Proportion/Mix 42.55 % 21.281% 8.51% 25.53% 2.13%

 Forms or Patterns of Capital Structure: 1. Equity Share Capital 1. Equity and Preference Share Capital 1. Equity, Preference and Debt

IMPORTANCE OF CAPITAL STRUCTURE:

Capital Structure refers to the relationship between the various long- term sources of finance. Financing the fixed assets is crucial problem as it is the long term decision which has future uncertainty. There should be proper mix of fixed interest or divided bearing debt and equity(Financial Leverage or Trading on Equity). The capital structure may not affect the earnings but it will affect the share of earnings. For example a Company has an Equity Capital of 1000 shares of Rs 100 each fully paid and earns an average profits of Rs 30,000. Now the company wants to make an expansion and needs another Rs 1,00,000.The sources available with the company are i. New Issue or Debt @ 10% Assuming that the company would earn same rate of profits suggest the source to be selected. Tax is assumed to be 50 %

New Issue of Debt @ 10%

Particulars Estimated Profits For 1,00,000: 30,000 For 2,00,000= 60,000 Less: Interest on Debt (10% on 1,00,000) New Issue 10% Loan 60,000 60,000

----60,000

10,000 50,000 25,000 25,000 1,000 25

Less: Tax @ 50% EAT Number of Equity Share EPS

30,000 30,000 2,000 15

As the EPS in the II plan (debt) is more company should go for raising loan. It is to be noted here that if the rate of Interest on loan is more than rate of return earned by the company the debts becomes adverse for the Company.

 Capital Gearing:
The relationship between owned funds and borrowed funds. It indicates the proportion of equity share capital ( E+RS) in the capital structure. Equity Capital > Borrowed Capital ------------- High Geared. Equity Capital < Borrowed Capital------------ Low Geared Equity Capital = Borrowed Capital------------ Evenly Geared

 Point of Indifference: Indifference Point : Equivalency Point : BEP Level of EBIT

It refers to the EBIT level at which EPS remains the same irrespective of debt equity mix. ROR on Capital = Rate of Interest on Debt = (X-I1 ) ( 1-T) PD) = (X-I 2)(1-T)- PD S1 S2 X= Indifference Point I1= Interest under alternative plan 1 I2 = Interest under alternative plan2 T= Tax Rate PD= Preference Dividend S1= Number of Equity Shares or amount of Equity Capital under alternative 1 S2= Number of Equity Shares or amount of Equity Capital under alternative 2

(X-11) (1-t) - PD S1

.=

(X-12) (1-t) - PD S2

Investment Required 10,00,000 Interest on Term Loan 10% Tax Rate 50% Debt Equity Rateo insisted 2:01 Alternative 1 Raising the entire amount of Rs 60,0,000 by the issue of equity shares, there by using no debt x Point of Indifference
Interest Under altenative 1 Interest Under altenative 2 10/100 x40% 0%

x
0 4

I1 I2
T PD S1 S2 Substituting the Values

Tax Rate Preference dividend Amount of Equity Capital under alternative 1 Amount of Equity Capital under alternative 2

50% 0

0.5 60 40

#VALUE! ((x-0) *(1-.5) -0))/60 .5x/60 = .5x-2/20 20(.5x) = 60(.5x-2) 10x = 30x -120 x = 30 - 10 = 120 x= 120/20 60 ((x-4) *(1-.5) -0))/20