CAPITAL STRUCTURE

FINANCIAL MANAGEMENT

Financial management is concerned with raising

financial resources and their effective utilisation
towards achieving the organisation goals. In
simple words Financial Management is
concerned with the planning effective use of an
important economic resources, namely capital
fund.
 CAPITAL
STRUCTURE
Capital Structure refers to composition
of large term sources of fund, such as
debentures, long term debts, preference
share capital and ordinary share capital
including reserves and surplus retained.
 TOTAL CAPITAL
STRUCTURE OF FIRMS..
TOTAL CAPITALS
EQUITY CAPITAL DEBT CAPITAL
1. EQUITY SHARE 1. TERM LOANS
2. CAPITAL PREFERENCE 2. DEBENTURES
3. SHARE CAPITAL 3. LONG TERM DEBTS
4. RETAINED EARNINGS 4. LIABILITY OTHER
5. DEFERRED PAY
 FEATURES OF
CAPITAL
STRUCTURE

1. Profitability :- Capital
structure must be in such a way
that it increases profit of business.
 2. Safety and solvency :- Capital
structure must built regarding future
safety and solvency. Excess presence
of debt capital make difficult for
firm not only pay annual interest but
also to redeem it's debt on maturity.
 3. Flexible :- Capital structure
must change time to time
according to situations in capital
market.
4. Control :- Helps the management
in retain Control over decision
making. It suggests debt should
preferd over equity whenever
additional funds need.
 5. Cost of issue and Flotation cost
Structure in such way that it reduce the
issue cost and Flotation cost as much as
possible.
Normal'- Cost of debt should lower as
compared to cost of equity.
 AFFECTING
CAPITAL
STRUCTURE
1. Nature of business :- Business
donot have stable income prefer
equity capital while business engaged
in public utility prefer more
debenture and preference share.
2. Purpose of Finance :- If need for
productive purpose - debentures
unproductive = Equity.
 3. Technology :- Firm use Capital
intensive techniques = Debentures

.
Firm use labour party intensive =
4. Requirements of investors :-
Investors who want high risk =
Equity
m
rF
ine e d l e s s r i s k =pr e f e r
debentures or prefer Share.
5. Nature and size firm :- Size large
then issue debentures or raise
borrowed money easily while size

. as
small then companyp prefer owned
source ofincom e.
6. Risk :- More risk = Equity
Less risk = Debentures or pref
Shares.
 THEORIES OF
CAPITAL
STRUCTURE..
1. NET INCOME APPROACH
11. NET OPERATING INCOME
APPROACH
111. TRADITIONAL APPROACH
1V. MODIGLIANI MILLER APPROACH
(MM APPROACH)
 NET INCOME APPROACH
• The theory propound that' is company can increase its
value and reduce my he overall cost of capital by
increasing the proportion of debts in its capital
structure. In simple words according to this approach
change in the capital structure of a company can
effect the market value of the firm.

• Debts. Market Value.Reduce overall cost of capital.

Y

Ke

K
o
Kd

O
Degree of financial X
leverage
 NET OPERATING INCOME
APPROACH..
• This theory is suggested by the DURAND.

• According to this approach change in the capital

structure of a company does not effect the market
value of the firm and the overall cost of capital is
remain consistent is implies that the overall cost of
capital remain the same whether the debt equity mix
in 50:50 and 20:80 or 0:100, thus there is nothing as
an optimal capital structure.
Y Ke

Ko

Kd

O Degree of financial X
leverage
 MODIGLIANI AND MILLER
APPROACH
• M&M approach is indentical with the net operating income approach of
taxes are ignored. However when the corporate taxes are assumed to
exist, their hipothesis is similar to the Net Income approach.

. by
• 1.. In the absence of taxes :- the theory prove that cost of capital is not
changes in the capitalstructure.

article of 1963 has recognised that the value of firm will increase and
• 2.. When the corporate taxes are exist :- Modigliani and Miller, in their
cost of capital will decreased with the use of debts.
Y

Ke

K
o
Kd

O Degree of financial
X
 THE TRADITIONAL
APPROACH
• The traditional approach is also known as intermediate
approach, it is the compromise between the two
extremes of net income approach and net operating
income approach.. According to this theory, the value of
firm can can be increased initially or the cost of capital
can be decreased by using more debts as the debts is
cheaper source of fund than equity. Thus the optimum
capital structure, can be reached by proper debts-equity
mix.
Y
Ke
Ko

K
d

O
Degree of financial X
 THANK
YOU..