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Capital Structure-B.V.Raghunandan, SVS College,Bantwal
Bharathi College,Mangalore
September 8, 2012
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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
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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
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Features of Debt
• Compulsory Payment of Interest
• Compulsory Repayment
• Only Fixed Interest
• No Annual Reports
• No Voting Rights
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Merits of Debt
• Benefit of Leverage• Cost of Raising Funds• Tax Advantage• Managerial Stability• Easier SEBI Norms• Flexible Features• Stable Market for
Securities
• Manageable Administrative Expenses
• Flexible Repayment• Easier Regulatory
Compliance
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Demerits of Debt• Compulsory Payment of Interest
• Solvency Affected
• Compulsory Redemption
• Charge on Assets
• Credit Rate Shopping
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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
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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
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Benefits of Equity Shares
• Basic for Capital Structure
• Better Solvency• Gestation Period• No Redemption• No Charge on Assets• No Shopping for
Credit Rating
• Evaluation of Share Value
• Better Image• Creation of Value• Public Knowledge of
Financial Information
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Demerits of Equity Shares
• Tax Implication• Management Control• High Rates of
Dividend• Lack of Flexibility• Stringent SEBI Norms• Huge Issue Expenses
• High Volatility in the Stock Market
• Speculation• Complex
Shareholder- Management Relation
• Rigid Corporate Governance
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DE RATIO=LONG TERM DEBT: NETWORTH
DE MIX=
Networth
TermDebtLong
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LONG-TERM DEBT=SECURED LOANS + UNSECURED LOANS
Long-Term Debt= Debentures +Bonds + Long Term Loans
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NETWORTH=SHAREHOLDERS’ FUNDS
Networth = Share Capital +
Reserves & Surplus –
Fictitious Assets
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Calculate Debt Equity Ratio of Precision Limited whose Balance Sheet as on March 31, 2004 was as given below
LiabilitiesAmount
(Rs) AssetsAmount
(Rs)
Equity Shares12% Preference SharesGeneral Reserve Profit & Loss A/c15% Mortgage DebtLoan from IDBICurrent Liabilities & Provisions
4,00,0002,00,000 50,000 50,000
15,50,0005,50,000
4,00,000
Fixed Assets
Current Assets, Loans & Advances
26,00,000
6,00,000
Total 32,00,000 Total 32,00,000
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Bentley Systems Limited had the following Balance Sheet as on 31-3-2004. Calculate Debt Equity Ratio.
LiabilitiesAmount
(Rs)Assets
Amount (Rs)
I SHARE CAPITAL; Equity Shares Pref.SharesII RESERVES & SURPLUSIII SECURED LOANSIV UNSECURED LOANSV CURRENT LIABILITIES & PROVISIONS
3,00,000 1,00,000
2,50,00010,00,000
2,00,000
50,000
I FIXED ASSETSII INVESTMENTSIII CURRENT ASSETS, LOANS & ADVANCESIV MISCELLANEOUS EXPENDITURE: Preliminary Exps Disc.on Issue of Shares Profit & Loss A/c
16,00,000 ---
2,00,000
40,000
30,000 30,000
19,00,000 19,00,000
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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 CreditorsBills Payable15% DebenturesLT LoansReservesProfit & Loss A/cEquity Share Cap
78,300 61,7009,00,0006,00,000 80,2001,19,8003,00,000
89,900 30,1006,00,0008,00,0001,17,5001,82,5004,00,000
CashS.DebtorsS.AdvanceStock Land & BldPlant & Ma.Goodwill
19,4002,80,600
75,0003,48,0004,07,0008,20,0001,90,000
17,6002,62,400
60,0003,70,0005,30,0007.90.0001,90,000
21,40,000 22,20,000 21,40,000 22,20,000
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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
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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.
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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
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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
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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
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Significance of Operating Leverage
• Sales-Operating Profit Relation• Role of Fixed Cost• Measurement of Operating Risk
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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.
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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
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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
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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
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Measurement of Financial Leverage
• Where there is no Preference Share
EBIT Financial Leverage= --------- EBT• Where there is preference share,
TP
EBT
EBITeverageFinancialL
1
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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
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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
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Combined Leverage
• Measures the impact on EPS for a given percentage of increase in Sales
• Combined Leverage = OL X FL
• Combined Leverage = EBT
onContributi
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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)
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THANK YOU