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Capital Structure
-B.V.Raghunandan, SVS College,Bantwal




     Bharathi College,
       Mangalore
    September 8, 2012

                                        Page 1
Meaning & Definition
          of Capital Structure



• Capital Structure is, ”the permanent
  financing of the firm represented by long-
  term debt, preferred stock and networth”
                 -Weston & Brigham
                                        Page 2
Debt



• Any source that gives the funding agency the
  creditorship status
• In the horizontal form of Corporate Balance
  Sheet, it is the sum of III and IV items(Secured
  Loans and Unsecured Loans) on the Liabilities
  side of the Balance Sheet
• In the vertical format, it is the II item (which again
  contains Secured Loans and Unsecured Loans) on
  the side of Sources of Funds                      Page 3
Features of Debt




     • Compulsory Payment of Interest

     • Compulsory Repayment

     • Only Fixed Interest

     • No Annual Reports

     • No Voting Rights
                                    Page 4
Merits of Debt

•   Benefit of Leverage   • Manageable
•   Cost of Raising Funds   Administrative
•   Tax Advantage           Expenses
•   Managerial Stability  • Flexible Repayment
•   Easier SEBI Norms     • Easier Regulatory
                            Compliance
•   Flexible Features
•   Stable Market for
    Securities


                                             Page 5
Demerits of Debt
• Compulsory Payment of Interest

• Solvency Affected

• Compulsory Redemption

• Charge on Assets

• Credit Rate Shopping
                                   Page 6
Equity




• Shareholders Fund or Ownership Capital
• Compulsory Component of the Capital Structure
• Sum of Equity Share Capital, Preference Share Capital and
  Reserves and Surplus
• Preference Shares are not a Popular Instrument
                                                        Page 7
Equity Shares

• Common Stock/Ordinary Shares
• Full Fledged Ownership
• Total Entitlement to the Assets
• Repayment After the Satisfaction of Every
  Other Claim
• Preemptive Right
• Entitlement for Dividend, Bonus Shares
  and Other Such Rewards
                                        Page 8
Benefits of Equity Shares

• Basic for Capital     • Evaluation of Share
  Structure               Value
• Better Solvency       • Better Image
• Gestation Period      • Creation of Value
• No Redemption         • Public Knowledge of
• No Charge on Assets     Financial Information
• No Shopping for
  Credit Rating


                                            Page 9
Demerits of Equity Shares
• Tax Implication        • High Volatility in the
• Management Control       Stock Market
• High Rates of          • Speculation
  Dividend               • Complex
• Lack of Flexibility      Shareholder-
• Stringent SEBI Norms     Management Relation
• Huge Issue Expenses    • Rigid Corporate
                           Governance



                                              Page 10
DE RATIO=LONG TERM DEBT:
NETWORTH


        Long TermDebt
DE MIX=
           Networth

                           Page 11
LONG-TERM DEBT=SECURED
LOANS + UNSECURED LOANS


Long-Term Debt= Debentures +Bonds + Long Term Loans




                                                Page 12
NETWORTH=SHAREHOLDERS’
FUNDS


 Networth = Share Capital +
         Reserves & Surplus –
         Fictitious Assets

                                Page 13
Calculate Debt Equity Ratio of Precision Limited whose Balance Sheet
             as on March 31, 2004 was as given below


                        Amount                              Amount
      Liabilities        (Rs)             Assets             (Rs)
Equity Shares            4,00,000 Fixed Assets            26,00,000
12% Preference Shares    2,00,000
General Reserve            50,000 Current Assets,
Profit & Loss A/c          50,000 Loans & Advances          6,00,000
15% Mortgage Debt       15,50,000
Loan from IDBI           5,50,000
Current Liabilities &
Provisions               4,00,000
              Total     32,00,000           Total         32,00,000




                                                               Page 14
Bentley Systems Limited had the following Balance Sheet
       as on 31-3-2004. Calculate Debt Equity Ratio.

                    Amount                             Amount
     Liabilities                       Assets
                     (Rs)                               (Rs)
I SHARE CAPITAL;                I FIXED ASSETS         16,00,000
   Equity Shares     3,00,000   II INVESTMENTS                ---
   Pref.Shares       1,00,000   III CURRENT ASSETS,
II RESERVES &                       LOANS & ADVANCES    2,00,000
SURPLUS              2,50,000   IV MISCELLANEOUS
III SECURED LOANS   10,00,000         EXPENDITURE:
IV UNSECURED                      Preliminary Exps        40,000
LOANS                2,00,000     Disc.on Issue of
V CURRENT                       Shares                    30,000
LIABILITIES           50,000     Profit & Loss A/c        30,000
    & PROVISIONS

                    19,00,000                          19,00,000


                                                           Page 15
2.3 Calculate Debt Equity Ratio of Suryodaya Chemicals 2000-01.
Comment on the variation in the debt equity ratio from the year 2000 to
                            the year 2001.


       Liabilities        2000        2001 Assets              2000        2001
Sundry Creditors        78,300      89,900   Cash             19,400      17,600
Bills Payable           61,700      30,100   S.Debtors      2,80,600    2,62,400
15% Debentures        9,00,000    6,00,000   S.Advance        75,000      60,000
LT Loans              6,00,000    8,00,000   Stock          3,48,000    3,70,000
Reserves                80,200    1,17,500   Land & Bld     4,07,000    5,30,000
Profit & Loss A/c     1,19,800    1,82,500   Plant & Ma.    8,20,000    7.90.000
Equity Share Cap      3,00,000    4,00,000   Goodwill       1,90,000    1,90,000

                     21,40,000   22,20,000                 21,40,000   22,20,000




                                                                        Page 16
Solution for Suryodaya Chemicals
                 2.3
• For 2000: Long Term Debt = Deb + LT
  Loans
     = 9,00,000 + 6,00,000= 15,00,000
• Equity = Eq.Shares + P&L A/c + Reserves
        = 3,00,000 + 1,19,800 + 80,200
        = 5,00,000
• Debt Equity Ratio = 15,00,000 : 5,00,000
                  = 3:1

                                       Page 17
DE Ratio for 2001
• LT Debt = 6,00,000 + 8,00,000 = 14,00,000
• Equity = 4,00,000 + 1,82,500 + 1,17,500
          = 7,00,000
DE Ratio = 14,00,000 : 7,00,000 = 2:1

 DE Ratio has come down due to lesser
 component of Debentures even though LT
 Loan has gone up. Every component of
 equity has also gone up.

                                          Page 18
Debt Equity Mix
• Significance of a High Debt Equity Mix: Reduced
  Tax Liability, Higher EPS
• Significance of a Low Debt Equity Mix: Better Risk
  Management
• Zero Debt Capital Structure and Its Relevance
  -Reducing Corporate Tax Rates
  -Equity Tied Image
  -Opportunity for Mergers & Acquisitions
  -Other Benefits
Trading on Equity

                                                 Page 19
Preparation of Statement of Income

• Leverages: Operating Leverage, Financial
  Leverage and Combined Leverage
• Degree of Leverages
• Significance of Each Leverage:
          -Sales-EBIT-EPS Relation
          -Measurement of Risk Levels
          -Behaviour of Costs
                                       Page 20
Operating Leverage

• The presence of fixed cost in the cost
  structure leads to operating leverage
• A certain percentage of increase in sales
  results in increases percentage of
  increase in EBIT
• Operating Leverage is a measure that
  determines the number of times the EBIT
  goes up due to a given increase in the
  sales
                                         Page 21
Significance of Operating Leverage


• Sales-Operating Profit Relation
• Role of Fixed Cost
• Measurement of Operating Risk




                                    Page 22
Quantitative Significance of
      Operating Leverage


• A Company had an operating leverage of
  3. If sales goes up by 20%, calculate the
  percentage of increase in EBIT.



                                         Page 23
Calculate the operating leverage
from the following details:

Sales 3,750 units; Variable Cost Rs.14
per unit; Price per unit Rs.16 and Fixed
Cost –Rs.4,000.

With the help of operating leverage,
calculate the percentage of increase in
EBIT for an increase of 10% in sales
                                     Page 24
Hercules Products Limited presents
the following details. You are
required to calculate the operating
leverage. Selling price per unit-
Rs.10; Sales-3 lakh units; variable
cost-Rs.6 per unit and fixed cost-
Rs.6,00,000. Analyse the situation
with an output of 4 lakh units


                                Page 25
Financial Leverage

• Financial leverage is the magnified impact
  produced on the EPS of a company for a
  given increase in the operating profit or
  EBIT.
• If a company has an operating leverage of
  3, a 20% increase in EBIT will result in a
  60% increase in the EPS

                                         Page 26
Measurement of Financial Leverage

• Where there is no Preference Share
                              EBIT
       Financial Leverage= ---------
                               EBT
• Where there is preference share,
                                EBIT
       FinancialLeverage
                                     P
                             EBT
                                   1 T




                                         Page 27
Statement of Income
                                    Amount
                                        Rs.
• Sales....                         --------
 (-) Variable Cost..                --------
                      Contribution --------
                     (-) Fixed Cost --------
 Operating Profit/ (EBIT)             -------
                     (-) Interest    -------
                            (EBT)
                       (-) Tax        -------
         Earning After Tax (EAT)       ----
•   (-) Preference Dividend             ----
                   Surplus Profit        ----
•                                 Surplus Profit
• Earning Per Shares (EPS)      =-----------------------
                                No of Equity Shares
                                                           Page 28
Significance of Financial Leverage


• Tool for Investment
• Relation between EBIT and EPS (A Financial
  Leverage of 3 means a 10% increase in EBIT
  will result in 30% increase in EPS)
• Measurement of Financial Risk



                                         Page 29
Combined Leverage

• Measures the impact on EPS for a given
  percentage of increase in Sales
• Combined Leverage = OL X FL

                      Contribution
• Combined Leverage =
                         EBT




                                       Page 30
Significance of Combined Leverage


• Total Risk Level of the Organisaion
• Measures the Relation between Sales and EPS
  (A Combined Leverage of 5 means a 10%
  increase in Sales will result in 50% increase in
  the EPS)



                                            Page 31
THANK YOU




            Page 32

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Capital structure b.v.raghunandan

  • 1. Capital Structure -B.V.Raghunandan, SVS College,Bantwal Bharathi College, Mangalore September 8, 2012 Page 1
  • 2. Meaning & Definition of Capital Structure • Capital Structure is, ”the permanent financing of the firm represented by long- term debt, preferred stock and networth” -Weston & Brigham Page 2
  • 3. Debt • Any source that gives the funding agency the creditorship status • In the horizontal form of Corporate Balance Sheet, it is the sum of III and IV items(Secured Loans and Unsecured Loans) on the Liabilities side of the Balance Sheet • In the vertical format, it is the II item (which again contains Secured Loans and Unsecured Loans) on the side of Sources of Funds Page 3
  • 4. Features of Debt • Compulsory Payment of Interest • Compulsory Repayment • Only Fixed Interest • No Annual Reports • No Voting Rights Page 4
  • 5. Merits of Debt • Benefit of Leverage • Manageable • Cost of Raising Funds Administrative • Tax Advantage Expenses • Managerial Stability • Flexible Repayment • Easier SEBI Norms • Easier Regulatory Compliance • Flexible Features • Stable Market for Securities Page 5
  • 6. Demerits of Debt • Compulsory Payment of Interest • Solvency Affected • Compulsory Redemption • Charge on Assets • Credit Rate Shopping Page 6
  • 7. Equity • Shareholders Fund or Ownership Capital • Compulsory Component of the Capital Structure • Sum of Equity Share Capital, Preference Share Capital and Reserves and Surplus • Preference Shares are not a Popular Instrument Page 7
  • 8. Equity Shares • Common Stock/Ordinary Shares • Full Fledged Ownership • Total Entitlement to the Assets • Repayment After the Satisfaction of Every Other Claim • Preemptive Right • Entitlement for Dividend, Bonus Shares and Other Such Rewards Page 8
  • 9. Benefits of Equity Shares • Basic for Capital • Evaluation of Share Structure Value • Better Solvency • Better Image • Gestation Period • Creation of Value • No Redemption • Public Knowledge of • No Charge on Assets Financial Information • No Shopping for Credit Rating Page 9
  • 10. Demerits of Equity Shares • Tax Implication • High Volatility in the • Management Control Stock Market • High Rates of • Speculation Dividend • Complex • Lack of Flexibility Shareholder- • Stringent SEBI Norms Management Relation • Huge Issue Expenses • Rigid Corporate Governance Page 10
  • 11. DE RATIO=LONG TERM DEBT: NETWORTH Long TermDebt DE MIX= Networth Page 11
  • 12. LONG-TERM DEBT=SECURED LOANS + UNSECURED LOANS Long-Term Debt= Debentures +Bonds + Long Term Loans Page 12
  • 13. NETWORTH=SHAREHOLDERS’ FUNDS Networth = Share Capital + Reserves & Surplus – Fictitious Assets Page 13
  • 14. Calculate Debt Equity Ratio of Precision Limited whose Balance Sheet as on March 31, 2004 was as given below Amount Amount Liabilities (Rs) Assets (Rs) Equity Shares 4,00,000 Fixed Assets 26,00,000 12% Preference Shares 2,00,000 General Reserve 50,000 Current Assets, Profit & Loss A/c 50,000 Loans & Advances 6,00,000 15% Mortgage Debt 15,50,000 Loan from IDBI 5,50,000 Current Liabilities & Provisions 4,00,000 Total 32,00,000 Total 32,00,000 Page 14
  • 15. Bentley Systems Limited had the following Balance Sheet as on 31-3-2004. Calculate Debt Equity Ratio. Amount Amount Liabilities Assets (Rs) (Rs) I SHARE CAPITAL; I FIXED ASSETS 16,00,000 Equity Shares 3,00,000 II INVESTMENTS --- Pref.Shares 1,00,000 III CURRENT ASSETS, II RESERVES & LOANS & ADVANCES 2,00,000 SURPLUS 2,50,000 IV MISCELLANEOUS III SECURED LOANS 10,00,000 EXPENDITURE: IV UNSECURED Preliminary Exps 40,000 LOANS 2,00,000 Disc.on Issue of V CURRENT Shares 30,000 LIABILITIES 50,000 Profit & Loss A/c 30,000 & PROVISIONS 19,00,000 19,00,000 Page 15
  • 16. 2.3 Calculate Debt Equity Ratio of Suryodaya Chemicals 2000-01. Comment on the variation in the debt equity ratio from the year 2000 to the year 2001. Liabilities 2000 2001 Assets 2000 2001 Sundry Creditors 78,300 89,900 Cash 19,400 17,600 Bills Payable 61,700 30,100 S.Debtors 2,80,600 2,62,400 15% Debentures 9,00,000 6,00,000 S.Advance 75,000 60,000 LT Loans 6,00,000 8,00,000 Stock 3,48,000 3,70,000 Reserves 80,200 1,17,500 Land & Bld 4,07,000 5,30,000 Profit & Loss A/c 1,19,800 1,82,500 Plant & Ma. 8,20,000 7.90.000 Equity Share Cap 3,00,000 4,00,000 Goodwill 1,90,000 1,90,000 21,40,000 22,20,000 21,40,000 22,20,000 Page 16
  • 17. Solution for Suryodaya Chemicals 2.3 • For 2000: Long Term Debt = Deb + LT Loans = 9,00,000 + 6,00,000= 15,00,000 • Equity = Eq.Shares + P&L A/c + Reserves = 3,00,000 + 1,19,800 + 80,200 = 5,00,000 • Debt Equity Ratio = 15,00,000 : 5,00,000 = 3:1 Page 17
  • 18. DE Ratio for 2001 • LT Debt = 6,00,000 + 8,00,000 = 14,00,000 • Equity = 4,00,000 + 1,82,500 + 1,17,500 = 7,00,000 DE Ratio = 14,00,000 : 7,00,000 = 2:1 DE Ratio has come down due to lesser component of Debentures even though LT Loan has gone up. Every component of equity has also gone up. Page 18
  • 19. Debt Equity Mix • Significance of a High Debt Equity Mix: Reduced Tax Liability, Higher EPS • Significance of a Low Debt Equity Mix: Better Risk Management • Zero Debt Capital Structure and Its Relevance -Reducing Corporate Tax Rates -Equity Tied Image -Opportunity for Mergers & Acquisitions -Other Benefits Trading on Equity Page 19
  • 20. Preparation of Statement of Income • Leverages: Operating Leverage, Financial Leverage and Combined Leverage • Degree of Leverages • Significance of Each Leverage: -Sales-EBIT-EPS Relation -Measurement of Risk Levels -Behaviour of Costs Page 20
  • 21. Operating Leverage • The presence of fixed cost in the cost structure leads to operating leverage • A certain percentage of increase in sales results in increases percentage of increase in EBIT • Operating Leverage is a measure that determines the number of times the EBIT goes up due to a given increase in the sales Page 21
  • 22. Significance of Operating Leverage • Sales-Operating Profit Relation • Role of Fixed Cost • Measurement of Operating Risk Page 22
  • 23. Quantitative Significance of Operating Leverage • A Company had an operating leverage of 3. If sales goes up by 20%, calculate the percentage of increase in EBIT. Page 23
  • 24. Calculate the operating leverage from the following details: Sales 3,750 units; Variable Cost Rs.14 per unit; Price per unit Rs.16 and Fixed Cost –Rs.4,000. With the help of operating leverage, calculate the percentage of increase in EBIT for an increase of 10% in sales Page 24
  • 25. Hercules Products Limited presents the following details. You are required to calculate the operating leverage. Selling price per unit- Rs.10; Sales-3 lakh units; variable cost-Rs.6 per unit and fixed cost- Rs.6,00,000. Analyse the situation with an output of 4 lakh units Page 25
  • 26. Financial Leverage • Financial leverage is the magnified impact produced on the EPS of a company for a given increase in the operating profit or EBIT. • If a company has an operating leverage of 3, a 20% increase in EBIT will result in a 60% increase in the EPS Page 26
  • 27. Measurement of Financial Leverage • Where there is no Preference Share EBIT Financial Leverage= --------- EBT • Where there is preference share, EBIT FinancialLeverage P EBT 1 T Page 27
  • 28. Statement of Income Amount Rs. • Sales.... -------- (-) Variable Cost.. -------- Contribution -------- (-) Fixed Cost -------- Operating Profit/ (EBIT) ------- (-) Interest ------- (EBT) (-) Tax ------- Earning After Tax (EAT) ---- • (-) Preference Dividend ---- Surplus Profit ---- • Surplus Profit • Earning Per Shares (EPS) =----------------------- No of Equity Shares Page 28
  • 29. Significance of Financial Leverage • Tool for Investment • Relation between EBIT and EPS (A Financial Leverage of 3 means a 10% increase in EBIT will result in 30% increase in EPS) • Measurement of Financial Risk Page 29
  • 30. Combined Leverage • Measures the impact on EPS for a given percentage of increase in Sales • Combined Leverage = OL X FL Contribution • Combined Leverage = EBT Page 30
  • 31. Significance of Combined Leverage • Total Risk Level of the Organisaion • Measures the Relation between Sales and EPS (A Combined Leverage of 5 means a 10% increase in Sales will result in 50% increase in the EPS) Page 31
  • 32. THANK YOU Page 32