Theories of capital structure ppt capital structure. Dec 24, 2019 candidates who are pursuing in class 12 are advised to revise the notes from this post. Capital budgeting under risk and uncertainties chapter7. Capital structure is defined as the amount of permanent short term debt,1 longterm debt, preferred stock, and common equity used to finance a firm.
Fina 4360 international financial management rauli susmel dept. Capital structure denotes means a firm funds its operations using some blend of equity plus debt. The suppliers of such working capital should not expect its return during the lifetime of the firm. Financial management ebook,lecture notes,pdf download for mba. This is particularly important from the point of view of financing. Theories of capital structure ppt capital structure cost. The goal of this chapter is to discuss the various theories that help to explain the determination of capital structure. On the positive note, debt payments force managers to pay out interest. Capital structure is referred to as the ratio of different kinds of securities raised by a firm as longterm finance. Capital structure detailed notes financial management unit 3 1. Indeed, the proof applies to all financial transactions because 20 fallacy. Capital structure is the proportion of all types of capital viz. When a business wants to grow it will need capital to drive its expansion. Freely browse and use ocw materials at your own pace.
Sorry for this video, try the updated video on capital structure theories. For most companies, the current and target capital structures are virtually identical, and calculating the target structure is a straightforward process. Capital structure management a companys capital structure refers to the combination of its various sources of funding. The cost depends on the health of the companys balance sheeta triple aaa rated firm can borrow at extremely low rates vs. In this article, we focus on analyzing the balance sheet based on a companys capital structure. By using regression analysis, the results of research on the effect of capital structure on profitability is 1 sda the ratio of shortterm debt to total capital positively associated. The objective of the firm should be directed towards the maximization of the value of the firm the capital structure, or average, decision should be examined from the point of view of its impact on the value of the firm. The emphasis of capital structure analysis is on the firms long range target capital structure, that is, the capital structure at which the firm ultimately plans to operate. Highly geared companies those companies whose proportion of equity.
Debt comes in the form of bond issues or longterm notes. Pdf capital structure management in nepalese enterprises. This article throws light upon the two main types of risks involved in capital structure decision of a firm. Chapter iii concepts and theories of capital structure and profitability. Meaning of capital structure capital structure refer to the proportion between the various long term source of finance in the total capital of firm a financial manager choose that source of finance which include minimum risk as well as minimum cost of capital. Financial management ebook,lecture notes,pdf download for. Notes on capital structure pdf capital structure cost of capital. Pdf capital structure choice is an important decision for a firm. Capital structure notes selfinstructional 126 material used for the mix of capitalization. Modigiliani miller approach and arbitrage financial management a complete study duration. The value of an enterprise depends on expected earnings and cost of capital. The nedc risk has an inverse relationship with the ratio of debt in its total capital.
Determinants of capital structure mba knowledge base. I will also share the lecture notes on this subject. Jun 25, 2019 the debt capital in a companys capital structure refers to borrowed money that is at work in the business. Essentially, management has to know how to determine the capital structure in order to maximize corporate, so that bankruptcy can be avoided. Further, since there exists a close correlation between sales fluctuations and invested amounts in. Capital structure factors influencing capital structure optimal capital structure dividend and dividend policy. When cost of capital is lowest and the value of the firm is greatest, we call it the optimum capital structure for the firms and at this point, the market price per share is maximised. The hurdle rate should be higher for riskier projects and reflect the financing mix used owners funds equity or borrowed money debt. Capital budgeting evaluation techniques 112 chapter6. Meaning, classification sources available for dividends dividend policy general, determinants of dividend policy.
Nonemployment of debt capital nedc risk capital structure decision. Capital structure theories may be classified on the basis of relevance of capital structure to the valuation of a firm. Capital structure is the mix of ownersupplied capital equity, reserves, surplus and borrowed capital bonds, loans that a firm uses to finance business operations. Pdf this study attempts to explain the capital structure pattern and its determinants for a penal set of 20 nonfinancial firms listed in nepse for. An overview kennedy prince modugu department of accounting faculty of management sciences university of benin nigeria abstract capital structure decision poses a lot of challenges to firms. According to ni approach a firm may increase the total value of the firm by lowering its cost of capital. This ebook is highly recommended for mba or management students. The finance function, the investment decision, capital structure decisions, dividend decisions, management of current assets. In this case it will be said that the capital structure of the company consists of rs 1,00,000 in equity shares, rs 1,00,000 in preference. The capital structure involves two decisions type of securities to be issued are equity shares, preference shares and long term borrowings debentures. A companys capital structure is arguably one of its most important choices. From the above table it is quite clear that the value of the firm v will be increased if there is a proportionate increase in debt capital but there will be a reduction in overall cost of capital. What is the best capital structure depends on several factors.
Sep 28, 2017 capital structure detailed notes financial management unit 3 1. What managers consider important in deciding on how much debt to carry. Most companies are funded by a mix of debt and equity, including some shortterm debt, some longterm debt, a number of shares of common stock, and perhaps shares of preferred stock. Capital structure planning capital structure dividend. A firms judicious use of debt and equity is a key indicator of a strong balance sheet. Capital structure concepts introduction financial management. Working capital management notes other funds must be raised judiciously. Capital structure a reading prepared by pamela peterson drake outline 1. B net operating income noi approach contrary to the ni approach the noi approach suggests that the capital structure decision of a firm is an irrelevant factor to the valuation of a firm i. The capital structure of a company is made up of debt and equity securities that comprise a firms financing of its assets. The capital structure of a company refers to the mixture of equity and debt finance used by the company to finance its assets.
In this case it will be said that the capital structure of the company consists of. In contrast, financial structure refers to the amount of total current liabilities, long term debt, preferred stock, and common equity used to finance a firm. Manager characteristics and capital structure university of. It is the employment of an asset source of finance for which. Aswath damodaran 2 first principles n invest in projects that yield a return greater than the minimum acceptable hurdle rate. A read is counted each time someone views a publication summary such as the title, abstract, and list of authors, clicks on a figure, or views or downloads the fulltext.
Candidates who are pursuing in class 12 are advised to revise the notes from this post. Capital structure detailed notes financial management unit 3. Capital structure management capital structure strategy. Corporate finance lecture note packet 2 capital structure. It is the permanent financing of a firm represented by longterm debt, preferred stock and net worth. Capital structure theories in hindi net income, net. These results imply to us that proper management of the capital structure will generate better returns to the company. Optimum capital structure f9 financial management acca. May, 2019 in this article, we focus on analyzing the balance sheet based on a companys capital structure. Financial managers are difficult to exactly determine the optimal capital structure.
It is synonymously used as financial leverage or financing mix. So it relates to the arrangement of capital and excludes shortterm borrowings. The capital structure puzzle is unravelled and a clear. Financial management is mainly concerned with how to optimally make various corporate financial decisions, such as those pertaining to investment, capital structure, dividend policy, and working capital management, with a view to achieving a set of given corporate objectives. Capital structure refers to the amount of debt market value of debt the market value of debt refers to the market price investors would be willing to buy a companys debt at, which differs from the book value on the balance sheet. According to this approach the wacc and total value of a firm are independent and are not. With the help of notes, candidates can plan their strategy for particular weaker section of the subject and study hard. Hi guys, i am sharing with you this excellent ebook on financial management in pdf format. Capital structure theories help us to understand the relationship between the capital structure, cost of capital and value of a firm. Cbse notes class 12 business studies financial management. Structure theories capital structure capital structure is the proportion of debt and preference and equity shares on a firms balance sheet optimum capital structure is that at which the weighted average cost of capital is minimum and thereby maximum value of the firm traditional approach the traditional approach argues that moderate degree of debt can lower the firms overall cost of. A net income ni approach durand presented the net income approach which suggested. Amount of permanent working capital remains in the business in one form or another. The tradeoff theory of capital structure postulates that managers attempt to.
Mm theorem was initially meant for capital structure. Meaning of capital structure capital structure is the permanent financing of the company represented primarily by long term debt and. From a technical perspective, the capital structure is the careful balance between equity and debt that a business uses to finance its assets, daytoday operations, and future growth. The capital structure decision can affect the value of the firm either by changing the expected earnings or the cost of capital or both. Exhibit 2 different capital structures for different. As salawu and agboola 2008 note that though the capital structure issue. Determining an appropriate mix of equity and debt is one of the most strategic decisions public interest entities are confronted.
Lecture notes financial management sloan school of. Capital structure and its 4 important theories ni, noi. If a firm does not use debt in its capital structure, it has to face the risk arising out of nonemployment of debt capital. Jul 23, 20 capital structure management a companys capital structure refers to the combination of its various sources of funding. From a technical perspective, the capital structure is defined as the careful balance between equity and debt that a business uses to finance its assets, daytoday operations, and future growth. Top 4 theories of capital structure learn accounting. From a tactical perspective however, it influences everything from the firms risk profile, how easy. Aswath damodaran 3 the objective in decision making n in traditional corporate finance, the objective in decision making is to maximize the value of the firm. Capital structure theories introduction capital structure decision is a significant decision in financial management. Capital structure planning free download as powerpoint presentation. Capital structure decision journal of finance and bank management. Analyzing a companys capital structure investopedia. Capital structure is also referred to as the degree of debts in the financing or capital of a business firm.
The mix of debt and equity used to finance the companys future profitable investment opportunities is referred to as capital structure. Theories of capital structure explained with examples. This decision in a private enterprise is directed towards the achievement of maximization of the shareholders wealth or value of the firm. Financial management is about analysing financial situation making financial decision setting financial objectives.
The debt capital in a companys capital structure refers to borrowed money that is at work in the business. A company may choose to look to its owners who have equity to raise the funds, by asking them to forgo. The financial risk arises on account of the use of debt or fixed interest. A21 that it is important to maintain optimum levels of debt and equity in that capital structure, decision makers must constantly be in control of capital structure determinants. Therefore, it will be valuable to managers to know the factors that may. Capital structure is the mix between owners funds and borrowed funds. Some companies could be allequityfinanced and have no debt at all, whilst others could have low levels of equity and high levels of debt. So, go ahead and check the important notes for class 12 business studies financial management. Find materials for this course in the pages linked along the left. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Most companies are funded by a mix of debt and equity, including some shortterm debt, some longterm debt, a number of shares of common stock. Capital structure notes corporate financial management studocu. Research abor 2005 entitled the effect of capital structure on profitability.
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