TOPIC 5-Cap Stru&Divi Poli
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Transcript of TOPIC 5-Cap Stru&Divi Poli
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IntroductionIntroduction
Capital structure of a
company refers to the
composition or make of itscapitalisation and it includes
all long-term capital
resources viz., loans,reserves, shares and
debentures.
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Capital structure is a relationship
between the various long-term
form of financing such asdebenture, preference share
capital and equity share capital
Forms of capital structure:It may consists of
- Equity shares only
- Equity and Preference shares
- Equity and debentures
- Equity, preference shares and
debentures
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Optimum Capital Structure:Optimum Capital Structure:
Capital Structure influences
the value of the firm through
the cost of capital and tradingon equity or leverage.
Combination of Debt and
Equity that leads to maximum
value of the firm.
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Consideration for maximizing the firmvalue;
- If the return is more than fixed cost,
better to prefer fixed cost funds like
debentures, loans and preference
capital.- When debt is used as a source of
finance, the firm saves considerable tax
benefit.
- The capital structure should be flexible.
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Effect of Financial Plan on EPS andEffect of Financial Plan on EPS andROE: Constant EBITROE: Constant EBIT
The firm is considering two alternativefinancial plans:
(i) either to raise the entire funds byissuing 50,000 ordinary shares at Rs 10
per share, or
(ii) to raise Rs 250,000 by issuing 25,000ordinary shares at Rs 10 per share and
borrow Rs 250,000 at 15 per cent rate ofinterest.
The tax rate is 50 per cent.
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Financial Plan
All-Equity
(Rs)
Debt-Equity
(Rs)
1. Earnings before interest and taxes, EBIT 120,000 120,000
2. Less: interest, INT 0 37,500
3. Profit before taxes, PBT = EBIT INT 120,000 82,500
4. Less: Taxes, T (EBITINT) 60,000 41,250
5. Profit after taxes, PAT = (EBIT INT) (1
T)
60,000 41,250
6. Number of ordinary shares,N 50,000 25,000
7. EPS = (EBIT INT) (1 T)/N 1.20 1.65
8. ROE = (EBIT INT) (1 T)/S 12.0% 16.5%
Effect of Financial Plan on EPS andEffect of Financial Plan on EPS andROE: Constant EBITROE: Constant EBIT
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Theories of Capital StructureTheories of Capital Structure
The important theories are;
1. Net Income approach (NI)
2. Net Operating Incomeapproach (NOI)
3. The Traditional approach
4. Modigliani and Millerapproach (MM)
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Pecking Order TheoryPecking Order Theory
Internal Finance Debt Finance
External Equity Finance
Firms use internally generated funds first,
because there are no flotation costs or negativesignals.
If more funds are needed, firms then issue debtbecause it has lower flotation costs than equity
and not negative signals.
If more funds are needed, firms then issueequity.
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Capital structureCapital structure FRICT AnalysisFRICT Analysis
Flexibility
Risk
Income Control
Timing
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7. Flexibility
8. Requirements ofinvestors
9. Capital market conditions10.Asset structure
11.Purpose of financing
12.Period of finance
13.Avail tax liability
Factors determining the capital structure:Factors determining the capital structure:
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Capital structure in practice:
Nature of Industry Capital structureElectrical Debt-equity less than 2:1
Chemical Conservative debt policy only for
expansion policy
Tea Internally generated funds
Fertilizer No specific type of debt or equity
Automobile Debt-Equity usually of 2:1
Pharmaceuticals Conservative policy of 1.7:1Consumer Focus on technology & production
electronics
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Meaning:Meaning:
The term dividend refers tothat part of profits of a
company which distributed by
the company among its
shareholders.
It is the reward of the
shareholders for investment
made by them in the shares of
the company.
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Dividend is Financing orDividend is Financing or
Investment Decision?Investment Decision?
Dividend decision is part of
Financing decision, because the
earnings available may beretained in the business for Re-
investment. If the funds are not
required, they may distributed asdividends.
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Affects:Affects:
Dividend policy of the firm affect
both the long-term financing
and wealth of the
shareholders. Therefore, thefirm distribute;
- reasonable amount as dividend
to its members,- retain the rest for its growth &
survival.
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Dividend Decision:Dividend Decision:
Acc. to one school of thought
dividend decision does not affect
the shareholders wealth.
Acc. to another school of
thought, dividend decision affectthe shareholders wealth.
Based on these two thoughts, it
can be classified into two
theories.
1. Relevance Theory
2. Irrelevance Theory
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Determinants of Dividend policy:Determinants of Dividend policy:
1. Legal restrictions2. Desire and type of shareholders
3. Nature of Industry
4. Age of the company
5. Future financial requirements6. Taxation policy
7. Control objectives
8. Requirements of institutional
investors.9. Liquidity position of the firm
10. Cost of external equity andretained earnings.
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Dividend Policy:Dividend Policy:
1. Stable dividend policy: Acc. to this,the percentage of earnings paid out
as dividends remains constant. Sothat, dividends fluctuate in line withearnings.
Earnings
Time
Dividend
Earnings
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2. Steadily changing dividend:2. Steadily changing dividend:
As per this policy, the rupee levelof dividends remains stable or
gradually increase or decreases.Earnings
Time
Dividend
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