FINANCING DECISIONS (CAPITAL STRUCTURE)

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CAPITALCapital refers to the funds borrowed from

different sources of finance by the business firm to acquire firm’s assets to be used in the operations of a firm.

CAPITAL STRUCTURECapital structure of a company refers to the

composition or components of its capitalisation and it includes all long – term capital resources (Loans, reserves, shares and bonds). It is made up of debt and equity securities and refers to permanent financing of a firm.

RELATIONSHIP BETWEEN CAPITAL STRUCTURE, CAPITALISATION & FINANCIAL STRUCTURE

CALCULATION OF CAPITALISATION

CALCULATION OF CAPITAL STRUCTURE

CALCULATION OF FINANCIAL STRUCTURE

FINANCIAL STRUCTURE

FORMS/TYPES OF CAPITAL STRUCTURE

Equity shares only

Equity and Preference shares

Equity shares and Debt

Equity shares, Preference shares & Debentures

FORMS OF CAPITAL

STRUCTURE

FACTORS INFLUENCING DECISION IN CAPITAL STRUCTUREINTERNAL FACTORSFinancial LeverageRiskGrowth and StabilityRetaining controlCost of capitalCash flowsFlexibilityPurpose of financeAsset structure

EXTERNAL FACTORSSize & Nature of businessInvestors interestCost of floatationLegal requirementPeriod of financePurpose of financeTaxation policyMarket conditionsAvailability of funds

CONCEPTS EBIT- EPS ANALYSIS

FINANCIAL BREAK-EVEN POINT

POINT OF INDIFFERENCE/ RANGE OF EARNINGS

OPTIMUM CAPITAL STRUCTURE

LEVERAGES – Financial, Operating & combined

CAPITAL GEARING

INVESTMENT DECISIONS

CAPITAL BUDEGETINGMeaning: Capital budgeting is a long-term

planning for making and financing proposed capital out lays.

Budgets:Purchase of fixed assets like land, plant,

machineryAddition, expansion, improvement of businessReplacement of fixed assetsResearch and development

NEED FOR CAPITAL BUDGETINGHuge InvestmentsLong term needs of firm

IrreversibleLong term effect

CAPITAL BUDGETING PROCESSIdentification of various investment

proposalsScreening of proposalsEvaluationFixing priorityFinal approvalImplementingPerformance review or feedback

Accept/Reject decisions: Independent projects and don’t compete with each other.

Mutually exclusive: Acceptance of one automatically rejects the other.

Capital rationing: Combinations of projects are selected due to funds limitations.

METHODS OF CAPITAL BUDGETING

Traditional•Pay back period (PBP)•Improved pay back•Accounting rate of return (ARR)

Modern•Net present value (NPV)•Internal rate of return(IRR)•Profitability Index (PI)