BUSINESS FINANCE

GROUP
PRESENTATION
Group #2
1. Hussain Fazal
2. Adeel Abbass
3. Zarish Memon
4. Sir Syed
5. Ghulam Fareed
6. Asad Iran
7. Bass Bibi
8. Saad Naeem
OUTLINE:
1. Capital Structure
2. Types of Capital Structure
3. Understanding Optimal Capital Structure
4. Theories on Capital Structure
 CAPITAL STRUCTURE
In corporate finance is the mix of various forms of external
funds, known as capital, used to finance a business .

FACTORS INFLUENCING CAPITAL

STRICTURE:
1. Financial Leverage or Trading on Equity:
2. Expected Cash Flows:
3. Stability of Sales
4. Market Conditions
5. Types of Investors
6. Legal Requirements
 FACTORS AFFECTING DECISION:
1. Financial flexibility
2. Tax flexibility
3. Business risk
4. Operating cash flow
5. Nature of industry and management style

IDEAL CAPITAL STRUCTURE:

1. Minimize coast of capital
2. Reduce business risk
3. Provide flexibility
4. Provides control
5. Maximize value of the firm
WAYS TO GET RIGHT DECISION:
1. Evaluation of company's need of capital.
2. Understand the credit rating to guarantee payment.
3. Liquidity to be prepared on “what if “ scenario.
4. Develop a clearly defined decision making framework .
IMPORTANCE OF CAPITAL STRUCTURE:
1. It determines the risk assume by the firm.
2. It determines the cost of capital of the firm.
3. It affects the flexibility and the liquidity of the firm.
4. It affect the control of the owner of the firm.
 Types of Capital Structure
1. Debt Capital
2. Equity Capital
3. Working Capital
4. Trading Capital

A business can acquire capital by borrowing. This is debt

capital, and it can be obtained through private or government
sources. For established companies, this most often means
borrowing from banks and other financial institutions or issuing
bonds. For small businesses starting on a shoestring, sources of
capital may include friends and family, online lenders, credit
card companies, and federal loan programs.
Debt Capital

A business can acquire capital by borrowing. This is debt

capital, and it can be obtained through private or government
sources. For established companies, this most often means
borrowing from banks and other financial institutions or
issuing bonds. For small businesses starting on a shoestring,
sources of capital may include friends and family, online
lenders, credit card companies, and federal loan programs.
Equity Capital

Private and public equity will usually be structured in the

form of shares of stock in the company. The only distinction
here is that public equity is raised by listing the company's
shares on a stock exchange while private equity is raised
among a closed group of investors.
Working Capital
A company's working capital is its liquid capital assets available for
fulfilling daily obligations. It is calculated through the following two
assessments:

Current Assets – Current Liabilities

Accounts Receivable + Inventory – Accounts Payable

Working capital measures a company's short-term liquidity. More

specifically, it represents its ability to cover its debts, accounts payable, and
other obligations that are due within one year.
Trading Capital

Any business needs a substantial amount of capital in order to

operate and create profitable returns. Balance sheet analysis is
central to the review and assessment of business capital.
Trading capital is a term used by brokerages and other
financial institutions that place a large number of trades on a
daily basis. Trading capital is the amount of money allotted to
an individual or the firm to buy and sell various securities.
Optimal capital structure
The optimal capital structure of a firm is the best mix of debt
and equity financing that maximises a company’s market
value while Minimising its cost of capital.
too much debt increases the financial risk to shareholders
and the return on equity that they require.
Thus, companies have to find the optimal point at which the
marginal benefit of debt equals the marginal cost.
Understanding Optimal
Capital Structure
The optimal capital structure is estimated by calculating
the mix of debt and equity that minimises the weighted
average cost of capital (WACC) of the company while
maximising its market value.
The lower the cost of capital, the greater the present value
of the firm’s future cash flows, discounted by the WACC.
This is basically the goal of almost every cooperate finance
department
Determining the Optimal Capital
Structure
A company with good prospects will try to raise capital using debt
rather than equity to avoid dilution and send any negative signals to
the market.
Announcements made about a company taking debt are typically
seen as positive news, which is known as debt signalling
If a company raises too much capital during a given time period, the
costs of debt, preferred stock, and common equity will begin to rise,
and as this occurs, the marginal cost of capital will also rise.
To gauge how risky a company is, potential equity investors look at
the debt/equity ratio
Another way to determine optimal debt-to-equity levels is to think
like a bank. What is the optimal level of debt a bank is willing to
lend?
An analyst may also utilise other debt ratios to put the company into
LIMITATIONS OF OPTIMAL
CAPITAL STRUCTURE
No Magic Ratio (debt to equity) to achieve optimal capital structure
The perfect ratio of debt to equity
◦ depends on
◦ Industry involved
◦ Line of business
◦ Firm’s development stage
◦ It varies over time
◦ Changing interest rates
◦ Changing regulatory environment

NOTE: Still it is better to have less debt and more equity in your
companies balance sheet, because investors generally want to invest
in companies that have strong balance sheets
Theories on Capital
Structure
1. Pecking Order
2. Trade-off
3. Agency Cost
4. Signaling
5. Market Timing
6. Life Stage
Theories on Capital
Structure
1. Pecking Order Theory: The pecking order theory states
that managers display the following preference of
sources to fund investment opportunities: first, through
the company's retained earnings, followed by debt, and
choosing equity financing as a last resort.

2. Trade-off theory: The trade-off theory of capital

structure says that corporate leverage is determined by
balancing the tax-saving benefits of debt against dead-
weight costs of bankruptcy.
3. Agency Cost theory:
The agency theory propose that the firms which having more
profitable assets use large portion of their earning for debt
payments thus this will increase their credit rating and they can
increase their debt capacity.

4. Signaling Theory:
The signalling theory was first coined by Ross (1977: 23) who
posits that if managers have inside information, their choice of
capital structure will signal information to the market.
5. Market Timing theory: The market timing hypothesis is a
theory of how firms and corporations in the economy decide
whether to finance their investment with equity or with debt
instruments. It is one of many such corporate finance theories, and
is often contrasted with the pecking order theory and the trade-off
theory.

6. Life Stage theory: Theoretically, an optimal level of leverage

maximizes the firm's value, thus taking on more debt than the
optimal will result in a lower valuation. The life cycle theory
argues that radically innovative industries are more likely to
default, which will lead to a lower optimal level of leverage.
THANK YOU!