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