SARVANRAJ P

 Capital structure refers to combination of

debt &equity which a company uses to
finance its long term operation.

 Maximization of shareholder wealth is a

primary objective.
 NI Approach
 NOI Approach
 Traditional Approach
 MM Approach
 Pecking Order Theory
 Suggested by David Durand and also called
“fixed ‘ke’ theory”.
 Increase the value and decrease the overall
cost of capital by increasing the debt in the
capital structure.
 Value = earnings/ wacc
 Firm will have maximum value when wacc is
minimum.
 NOI approach is opposite of NI approach
 Value of the firm is not affected by change in
capital structure .
 Increase in debt increases the risk of equity
shareholders and hence the cost of equity
increases.
 Market value depend on the risk associated
with the business.
 Reducing cost of capital or increasing the
total value by increasing the debt proportion
in capital structure.
 Debt should exist up to specific point
 Above the point wacc increases and market
value decreases.
 Value of the firm independent of the capital
structure.
 The debt-equity mix is irrelevant in
determining the value of the firm.
 Market value depends on operating income
and risk involved in the investment.
 Theory suggests that there is an order of
preferences for the firm of capital sources
when funding is needed.
 Hierarchy for pecking order theory
internal financing
external financing , debt
external financing ,equity.