Professional Documents
Culture Documents
FM Capital Structure
FM Capital Structure
FM Capital Structure
1. 2. 3. 4.
Proportion of Debt and Equity Financial leverage for the Firm Cost of Capital Average cost of Capital - weighted average of Cost of Debt and Equity Capital Structure Decisions PBIT /EPS Analysis ROI ROE Analysis
5. 6.
7.
8.
DIVIDEND DECISIONS :
Why Companies pay Dividend Dimensions of Dividend Policy
Payout Ratio :
Fund Requirement Liquidity Access to External Finance Shareholder preference (Immidiate Dividend or Capital appreciation) Taxes Difference between cost of external financing and retained earning
Stability:
DIVIDEND DECISIONS :
Dividend Policy Formulation :
Funds through retained earning or external equity External Equity Right Issue or Dilution Target Payout Ratio with Target Debt/Equity Ratio Avoid Dividend cuts Cash-flow requirement for working capital and long term investment
Legal Aspects :
Payment out of current years Profit Transfer to Reserve rule
PROCEDURAL ASPECTS :
Board Resolution
Shareholders Approval
Record Date Dividend Payment Warrants/Electronic transfer Transfer to Dividend Accounts Dividend tax paid by Company, income is free in the
hands of Investors
Cost of debt
: : : :
Rs 40 m Rs 10 m 18% 12%
(b) What happens to the average cost of capital , if it employs Rs 100 m of debt to finance a project which earns an additional operating income of Rs 20 million ? Assume that the net operating income (NOI) method applies and there are no taxes.
Solution :
(a) The value of debt and equity are as follows:
Value of debt = (Rs 10 million / 0.12) = Rs 83.33 million Value of equity = (Rs 30 million/0.18) = Rs 166.67 million Hence, the average cost of capital for Avinash is : 83.33 166.67 12 12x --------- + 18 x --------- = 16 per cent 250.00 250.00
project which earns an additional operating income of Rs 20 million, the following financial picture emerges:
Net operating income Interest on debt Earnings on equity Market value of equity Market value of debt Market value of firm : : : : : : Rs 60 million ( 40 + 20) Rs 22 million Rs 38 million Rs 211.11 million Rs 183.33 million Rs 394.44 million
12 x
Falcon Limited Plans to raise the additional capital of Rs 10 million for financing an expansion project. In this context, it is evaluating two alternative financing plans : (i) issue of equity shares (1 million equity shares at Rs 10 per share), and (ii) issue of debentures carrying 14 per cent interest.
What will be the EPS under the two alternative financing plans for two levels of PBIT. Say Rs 4 million and Rs 2 million ?
PBIT: 4,000,000
1,000,000
2,000,000
300,000
1300000
1,000,000
2,000,000
300,000
1300000
2,000,000
2,000,000
1,000,000
1000000
0.50
1.00
0.30
1.30
Korex Limited, which requires an investment outlay of Rs 100 million, is considering two capital structures:
Capital Structure A (Rs in million) 100 Equity 0 Debt Capital Structure B (Rs in million) 50 50
Equity Debt
While the average cost of debt is fixed at 10 per cent, the ROI (defined as PBIT divided by total assets) may vary widely. The tax rate of the firm is 50 per cent.
Based on the above information, calculate the relationship between ROI and ROE (defined as equity earnings divided by net worth) under the two capital structures, A and B, at ROI levels of 5,10,15,20 and 25% :
ROI PBIT (Rs in million) Interest Profit after Tax Tax Profit after Tax Return on equity
5% 10% 15% 20% 25% 5 0 5 2.5 2.5 10 0 10 5 5 15 7.5 7.5 15 0 20 10 10 20 0 25 12.5 12.5 25 0
2.5% 5% 7.5%
10% 12.5%
15% 20%
Share Buyback :
Company buys its own shares Methods : Tender method, Open market purchase method Impact : Share capital drops, debt equity ratio increase Legality : Started in India from 1998 only
10% of the shares can be bought per year with Board Resolution, excess by Special Resolution. Post Buyback, Debt equity ratio not to exceed 2.1 Buyback cannot exceed 25% of shareholders funds. Further issue of equity after 6 months Buyback to be done through open offer route Cannot be done as negotiated deal Process to be handled by Merchant Bankers, who does due diligence.