Corporate Finance for Beginner's :- Capital Structure Theories

Unit-3 Financial
Decision




Capital
Structure

, Capital
Coverag
Structure
•e – Structure concept
Capital • Capital Structure theories –
• Capital Structure planning  Net Income
 Net Operating Income
• Concept of Value of a Firm
 Modigliani-Miller
• Significance of Cost of
 Traditional Approach
Capital (WACC)

,Capital
Structure
Capital structure can be defined as the mix
of owned capital (equity, reserves & surplus)
and borrowed capital (debentures, loans
from banks, financial institutions)
Maximization of shareholders’ wealth is
prime objective of a financial manager. The
same may be achieved if an optimal capital
structure is designed for the company.
Planning a capital structure is a highly
psychological, complex and qualitative
process.
It involves balancing the shareholders’

, Planning the Capital
Structure
Important
Return: ability to generate maximum returns to
the shareholders,
Considerations –
i.e. maximize EPS and market price per share.
 Cost: minimizes the cost of capital (WACC). Debt
is cheaper than equity due to tax shield on
interest & no benefit on dividends.
 Risk: insolvency risk associated with high debt
component.
 Control: avoid dilution of management
control, hence debt preferred to new equity
shares.
 Flexible: altering capital structure without