Capital Structure

Accounting Principles

• Generally Accepted Accounting Principles (GAAP)

• Method of Valuation

• Cost Calculation
 Accounting Principles

• Generally Accepted Accounting Principles (GAAP)

• Method of Valuation
• Asset Based Approach
• Earning Value Approach
• Market Value Approach
• Cost Calculation
 Method of Valuation
• Asset Based Approach
• Going Concern Approach
• Liquidation Approach

• Earning Value Approach

• Market Value Approach

 Accounting Principles

• Generally Accepted Accounting Principles (GAAP)

• Method of Valuation

• Cost Calculation
• Cost of Capital
• Weighted Average Cost of Capital
• Can we maximise shareholders wealth by varying
the proportions of debt and equity in a company’s
capital make up?
 Capital Structure

• Debt : Equity
• Debt to Equity Ratio
• Debt to Capital Ratio
• Low Leverage
• High Leverage
Imagine a business with the following financial information:
• $50 million of assets
• $20 million of debt
• $25 million of equity
• $5 million of annual EBITDA
• $2 million of annual depreciation expense
• Now calculate each of the 4 ratios outlined above as follows:
• Debt/Assets
• Debt/Equity
• Debt/Capital
• Debt/EBITDA
 Capital Structure

Equity Debt
• Preferred Stock • Long Term Debt
• Common Stock • Short Term Debt
• Retained Earnings
 Problem #1

At the end of its prior fiscal year, December 31, M Company has assets of
$300,000 and liabilities of $175,000.
Required:

• What is owner's equity at the start of the current fiscal year?

• What is owner's equity at the end of the current year, if assets increased by
$85,000, liabilities increased by $35,000?
• What is the increase or (decrease) in owner's equity for the year?
• What is the net income (or net loss) for the year assuming there were no
additional investments and dividends of $15,000 were paid.
 Problem #2

H Company reported the following information for the year. During the year, an
additional $25,000 of capital stock was issued and no dividends were paid.

Total Assets Total Liabilities

Beginning of the year $500,000 $200,000
End of the year $625,000 $250,000

Required:
Determine the net income/net loss for the year.
 Problem #3

T Company’s balance sheet reported the following total assets and total liabilities
for the year. During the year, an additional $70,000 of capital stock was issued
and $45,000 of dividends were paid.
Total Assets Total Liabilities
Beginning of the year $625,000 $255,000
End of the year $640,000 $385,000

Required:
Determine the net income/net loss for the year.
Cost Calculation

• Cost of Capital
• Financing Cost
• Opportunity Cost

• Weighted Average Cost of Capital

• WACC = (Proportion of total funding that is equity funding ) x (Cost of equity)

+ (Proportion of total funding that is debt funding) x (Cost of Debt)
 Cost Calculation
• A firm is currently faced with an investment
opportunity. Assume the following:

Project 1 Project 2
• Cost=100,000 • Cost=100,000
• Life=20 years • Life=20 years
• Rate of Return=7% • Rate of Return=12%
• Cost of debt financing • Cost of equity financing
available=6% available=14%
 Strategic Objectives of an Organization

• Financial Objectives

• Non Financial Objectives

 Strategic Objectives of an Organization

• Value of Money
• Measurement of value of Currency
• Present Value of Money
• Future Value of Money
• Maximizing Shareholder’s Wealth
 Value of Money
• Measurement of Value f Money
• Exchange Rate
• Treasury Notes
• Foreign Exchange Reserves
 Value of Money
• Present Value of Money
• PV = FV (1 + r) n • FV = Future value of money
• PV = Present value of money
• i = interest rate
• n = number of compounding periods per year
• t = number of years
• FV = PV (1 + r)
• FV = Future value of money
• PV = Present value of money
• i = interest rate
• n = number of compounding periods per year
• t = number of years