Capitalization

The success of modern business depends largely on the amount of capital employed in the business. Capitalization refers to the decision regarding determining the optimal capital requirement of the business.

Capitalisation

Cost theory considers the amount of capitalisation on the basis of cost of various assets required to set up and run the business activities. Where as the Earnings Theory considers the future expected earnings of the company on the basis of appropriate capitalisation rate. Over-capitalisation refers to the excess of capital compared to the requirement of the company where as under-capitalisation indicates the real worth of assets over the share capital and debentures.

Capitalisation
Both over-capitalisation and under capitalisation are undesirable, among which the over-capitalisation is more dangerous to the business. pitfall of Over-Capitalisation  Idle & Unproductive Capital  Unnecessary Cost of Carrying Capital  Possibility of Misuse of Capital  Repayment & Exit is difficult, tedious, costly & time consuming

Sources of Funds

 3. 4.

After deciding the capital requirement of the business the main task is to choose the sources of Finances available so that there is optimal balance between the sources. Following are some of the sources of Financing: Shares Debentures

Sources of Funds
3.TermLoans 4.Public Deposits 5.Lease Financing 6.Hire Purchase 7.Retained Earnings.

Capital Structure
 Capital

Structure refers to proportion of sources of the capital to be borrowed as required by the business. Often called as Capital Mix  Cost of Capital refers to the cost incurred by the business in acquiring the capital from various sources.

Capital Structure

Cost of debt is the interest to be paid on the debt funds. 9% Debentures worth Rs.1 crore and rate of Tax 40%. Then Cost of Debt is 5.4% and not 9% 9% * 1 Cr. - 40% ( 9% * 1 Cr. ) I.e. Tax Saving Cost of Equity is the expectations of the shareholders towards the dividend paid by the company on the shares.

Leverages &Theory of Capital Structure
Leverage refers to influence one financial variable on the other. The variables are the costs, output, sales revenue, earnings per share etc.  Concepts: Explained by Example Sale Price Rs.100 per unit, Variable Cost Rs.60 per unit. EBIT = 75, EBT =60 1.Operating Leverage: It is the firm’s ability to use fixed operating costs to magnify effects

Leverages & Theory of Capital Structure
of changes in sales on its earnings before interest and taxes.  Operating Leverage is calculated as Contribution i.e. (Sales-Variable costs) Earnings before Interest & Tax. = (90-40) / 75

Leverages &Theory of Capital Structure
 Financial

Leverage refers to the ability of the firm to use its fixed operating costs to magnify the effects of changes in operating profits on the firm’s earnings per share. It is calculated by: Earnings before Interest and Taxes Earnings before Tax = 75 / 60

Leverages & Theory of Capital Structure
 Combined

Leverage refers to the effect of percentage change in sales to percentage change in Earnings Per Share. Combined leverage is calculated by:

Contribution Earnings before Taxes. = 60 / 60

Leverages & Theories of Capital structures
The capital structure refers to the combination of different financial sources for the capital of the business in the most economical and efficient manner.  The theories of Capital structure includes 1.Net Income approach. 2.Net Operating income approach. 3.Traditional approach. 4.Modigliani-Miller Approach.

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